If Government Spends Less, Are We Sunk?

by Jeffrey Tucker
May. 03, 2012

Easy prediction: Congress will not cut spending. The hysteria in Washington is for naught, as usual. There will be no "austerity," at least not the kind brought on by cuts in government. Nor will there be curbs on the Fed. Our credit-drenched, phoney-money culture would never stand for it.

But let's just pretend that this fantasy did come true, for once. What would happen?

Try not to be intimidated by what the supposed experts say; rather, think about the following sentence using logic and critical intelligence: "Cutbacks in government spending… will eat into growth." This statement of seeming ironclad truth was pushed in an editorial in The New York Times. It is without argument or evidence, but it presumes the truth of the "fiscal multiplier effect."

Let us see. Incontrovertible truth: government has no resources of its own. Everything it has it takes from you and me or borrows. How does forcible extraction of private resources in the service of bigger bureaucracies and transfer payments cause new kinds of prosperity to come into existence? What you take, you have, but there is no turning stones into bread here.

It's even worse than pure redistribution of wealth. It is actually destruction of wealth for government to rob and spend. This is because it is taking resources from highly valued uses to channel them into less-valuable uses. We know this because it would not happen absent the use of force. People's preferences for the use of resources are being overridden.

How does that create or sustain prosperity? Of course, it doesn't. If it did, there would be no economic problem to solve, no need for savings and investment, no need for risk taking or economic calculation of profit and loss. To create prosperity, you would need only unleash the looter state. Absurd.

In fact, the opposite is true. Cuts in government spending release resources from less-valued uses into more-valued uses. It puts wealth back into the hands of private parties, in which it can be saved and invested with economic rationality. The Keynesians have it exactly backward. Defunding bureaucracies and transfer payments provides new and productive funding for entrepreneurs and wealth creation in the private sector.

And hey, this isn't just speculation. This is precisely what happened after World War II. FDR died and the political system went into full-scale upheaval. His successor, President Harry Truman, didn't have his stride, a congressional election produced unexpected results, many wartime controls were allowed to expire and, for a variety of reasons, the wartime leviathan began to melt away.

David Henderson beautifully illustrates the point:

"In the four years from peak World War II spending in 1944 to 1948, the U.S. government cut spending by $72 billion — a 75% reduction. It brought federal spending down from a peak of 44% of gross national product (GNP) in 1944 to only 8.9% in 1948, a drop of over 35 percentage points of GNP.

"While government spending fell like a stone, federal tax revenues fell only a little, from a peak of $44.4 billion in 1945 to $39.7 billion in 1947 and $41.4 billion in 1948. In other words, from peak to trough, tax revenues fell by only $4.7 billion, or 10.6%. Yet the economy boomed. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But during the years from 1945-48, it reached its peak at only 3.9% in 1946, and for the months from September 1945 to December 1948, the average unemployment rate was only 3.5%."

I was just yesterday listening to Paul Krugman (debating Ron Paul) explain that it was Keynesian economics that gave rise to the economic boom in the United States following the Second World War. This is the kind of claim that causes the jaw to drop to the floor. Ron correctly responded that it was the spending and tax cuts, with the release of controls, that did that. In fact, the Keynesians at the time predicted complete disaster just when the very opposite happened.

Paul Samuelson, the leading American Keynesian, warned against dismantling wartime planning. He wrote in 1943 that such a plan would usher "in the greatest period of unemployment and industrial dislocation which any economy has ever faced."

This was his prediction. Of course, the exact opposite occurred!

The most-spectacular thing concerns the reabsorption of military workers into civilian life. More than 10 million people who might have been unemployed found work. This was a readjustment that hardly anyone expected, and a fantastic tribute to the capacity of the market economy to deliver seeming miracles that defy all the predictions of disaster.

Again, Henderson writes:

"Indeed, in just the 11-month period between August 1945 and July 1946, the number of people in the U.S. military fell from 12 million to 2.7 million, a drop of 9.3 million. Over those same 11 months, civilian employment grew from 53.6 million to 57.8 million, an increase of 4.2 million people. The number of unemployed people did increase, rising from 0.8 million to 2.3 million, but with a civilian labor force of 60.1 million, the 2.3 million unemployed people implied an unemployment rate of only 3.8%."

Remarkable, isn't it? Look at our current labor problems. They are incomparable. And we are living through an astounding technological boom that should have created a brilliant market for workers in all sectors. Instead, with the Keynesians in charge, we have persistent unemployment and falling labor participation! They keep being shown wrong, and yet they have no shame and continue to claim to have been right.

Given this history, the prescription for our current troubles reverses all the conventional wisdom. Cut government spending dramatically. Cut taxes. Get rid of regulations and controls. In sum, free the economy! You can say it and prove it ten thousand times, but it makes no difference. A convinced Keynesian is a tough nut to crack.