Innovation Blog

Grow by Spending Less?  Grow by Spending More? Economists’ Silence of the Lambs

By Shlomo Maital


 silent lambs

In his latest New York Times column, Nobel economist Paul Krugman cites a recent report by “Republican staff members of the Congressional Joint Economic Committee   titled “Spend Less, Owe Less, Grow the Economy”. ***   They argue that “slashing government spending and employment in the face of a deeply depressed economy would actually create jobs.”

   Krugman acerbically trashes this report’s argument: “ ‘A smaller government work force increases the available supply of educated, skilled workers for private firms, thus lowering labor costs.’  Dropping the euphemisms, what this says is that by increasing unemployment, particularly of “educated, skilled workers” — in case you’re wondering, that mainly means schoolteachers — we can drive down wages, which would encourage hiring.”

    Slash wages to increase employment?  Keynes long ago noted there are ‘price’ and ‘income’ effects.  Lower wages cuts the price of labor and may boost demand for it. But lower wages reduce overall income, which reduces spending and demand and cuts demand for labor. And income effects almost always overwhelm price effects.

   Moreover, there is the ‘confidence fairy’, which the Republicans invoke.  Lower government spending will boost confidence, they say, and hence spending and employment. Really?  Thousands more of unemployed teachers will boost confidence? With millions more in doubt if they have a job tomorrow? 

  *  What is the evidence?  Britain tried austerity and lower spending, and it is seriously weakening the British economy.  GDP there fell by 0.5 % in Q4 2010, after a round of budget cuts by the new Conservative government. 

    The problem is, it is not crystal clear that HIGHER government spending will do the trick, either.  Higher spending worries people because they know they will be passing on massive debt to the future generation. 

    * What is the evidence? Japan. Japan tried to spend and borrow its way out of recession, and now its national debt is a huge 2.5 times GDP.  It didn’t work.  People simply saved more to set aside funds to pay off the higher future taxes needed to repay the debt. 

   So – lower government spending doesn’t work. Higher government spending doesn’t work.  What DOES work???    The silence of the economist lambs is deafening.  My profession divided between “Republicans” (spend less), with no evidence, and “Democrats” (spend more), with no evidence, and nothing even slightly creative to say to resolve the dilemma?

 ***    Spend Less, Owe Less, Grow the Economy.   Executive Summary March 15, 2011