Government Spending Doesn’t “Stimulate” the Economy

The US government ran a record $1.7 trillion deficit through the first half of fiscal 2021. That’s a staggering budget shortfall, but only a symptom of the real problem – excessive government spending. We’re told this will “stimulate” the economy. But in the long run, it does no such thing.

Conventional wisdom tells us that the government needs to spend money during an economic downturn to “stimulate” the economy. It has done that in spades over the last year, capped by Biden’s most recent stimulus bill. In just six months, Uncle Sam spent a staggering $3.41 trillion. And there is no end in sight to the government spending. Biden and Congress are already fleshing out a new “infrastructure” spending plan.

Therein lies the real problem. We could fix the budget shortfall by hiking taxes, but that wouldn’t solve the problem. As economist Frank Shostak wrote in an article published by the Mises Institute, what ultimately matters for the health of the economy is not the size of the budget deficit but the size of government outlays. In other words, the percentage of resources that government diverts to its own activities.

By that measure, the economy is terminally ill.

It’s crucial to understand that government is not a wealth generating entity. It is a wealth redistributing entity. It takes resources and moves them around like pieces on a chessboard. As Shostak put it, the more a government spends, the more resources it takes from true wealth generators. This is true whether the government gets its “revenue” from taxing, borrowing or simply printing money. And it undermines the wealth-generating process in the economy.

For instance, if the government plans to spend $3 trillion and funds these outlays by means of $2 trillion in taxes, there is going to be a deficit, or a shortfall, of $1 trillion. Since government outlays have to be funded, this means that in addition to taxes the government has to secure some other means of funding, such as borrowing or printing money.

The government is going to employ all sorts of means to obtain resources from wealth generators to support its activities. Hence, what matters here is that government outlays are $3 trillion, and not the deficit of $1 trillion.

For instance, if the government lifts taxes to $3 trillion and the deficit is erased as a result, would this alter the fact that the government still takes $3 trillion of resources from wealth generators?

This means the effective tax that the government imposes on wealth generators is determined by government outlays.

An increase in government outlays sets in motion an increase in the diversion of wealth from wealth-generating activities to non-wealth-generating activities. This results in economic impoverishment. So in this sense, an increase in government outlays to boost the overall economy’s demand should be regarded as bad news for the wealth-generating process, and hence to the economy.

The fact that government has to take resources for its projects tells you something about the nature of those projects. It reveals that the general population doesn’t value those projects to the same degree as the political class. If they were as highly valued, they would be privately funded. In effect, the government is saying to the citizenry, “We don’t think you have the right priorities. We are going to take your resources and use them on our priorities.”

As Shostak put it, increases in government spending mean that wealth producers are forced to part with their wealth in exchange for unwanted, or at least lower priority, projects.

This implies that producers are forced to exchange more for less, and obviously, this impairs their well-being.

The greater the amount of non-market-related projects the government undertakes, the more real wealth is taken away from wealth producers. Note that the real wealth is diverted from the private sector by means of taxation, borrowing, or money printing.

Again, the magnitude of the diversion is determined by the extent of government activities. Observe that it does not matter as such whether the government diverts real wealth by means of taxation, or by means of borrowings or by means of money printing. What matters is that the government diverts real wealth.

One should ask the question: what makes anybody things a bunch of politicians and bureaucrats are better equipped to determine how wealth should be used than millions of individuals cooperating voluntarily in the free market? Central planners have a pretty lousy track record of central planning. If you doubt this, look at the extreme cases – the USSR or North Korea.

Here’s the real rub – no matter how much the government spends, no matter how much it does with the wealth that it confiscates, it can’t make its projects economically viable.

Consider Biden’s infrastructure plan. The argument is that the US needs to update its bridges, roads and become a “greener” economy. Since the private sector won’t do the job, the government has to step in. But nobody stops to consider why the private sector won’t do the job. As Shostak explains, the private sector found them too expensive. The private sector cannot afford these projects given the state of real wealth.

If the private sector does not consider itself “rich” enough to pursue such projects, how can the government justify embarking on such undertakings? After all, the government is not a wealth-generating entity. Since the government will be required to divert real wealth from the private sector, its actions only mean that the government is going to impoverish the private sector. This is going to result in a decline in the living standards of individuals.

Now, if the size of the pool of real savings is not large enough to afford better infrastructure, then time is required to accumulate the real savings to be able to secure better infrastructure. The buildup of the pool of real savings cannot be made faster by raising government outlays. On the contrary, that will undermine the process of real savings formation.

What is required is the curtailment of government outlays. This is going to speed up the process of real savings accumulation, i.e., it will strengthen the pool of real savings.

The bottom line is that stimulus isn’t stimulating. It’s hanging a millstone around the economy’s neck. Even if there was no budget deficit, all of this government spending would be problematic. And the fact that most of the money the government spends is ultimately being printed out of thin air. This creates another problem — inflation.

As Peter Schiff put it earlier this year, the US government is actually sedating the economy with stimulus.