by Mario Rizzo
“And government spending is as good as anybody else’s.” Brad DeLong seems to think so. But the idea is only plausible because it has been repeated many times and because it is a politically convenient “truth.”
I think everyone would agree that we have a complex economy. There is a vast and intricate division of labor, specialization of industry, and interdependencies of a high order. But there is more. The division of labor is supplemented by a social division of knowledge and its corresponding “division of capital.” Capital is not a homogeneous mass nor is investment simply homogeneous addition to that mass. Specific capital goods are arranged in complementary groupings. These are constantly undergoing changes in response to local conditions. Under extraordinary circumstances, however, when the direction of production has been distorted by excessively low interest rate policies over several years, there are many capital groupings within industries and across industries that are inappropriate.
So when DeLong, among others, says that government spending is as good as private in restoring employment, he is speaking against the whole thrust of the principle of efficient resource allocation. The essence of our recessionary problem is not the fall in aggregate demand and the lack of business confidence that accompanies it. First, it is the misallocation of resources produced by excessive risk-taking and by excessive expansion of interest-sensitive sectors. (These were generated by excessively low interest rates over the past several years.) Second, it is the uncertainty that is natural to the discovery of more appropriate combinations of resources. Third, it is the endogenous uncertainty created by the fits and starts of stimulus, bailout and unclear monetary policies.
When government adds to investment as a result of fiscal stimulus or directed monetary expansion (like buying mortgage-backed securities, student loans, etc) it does not act as a super-entrepreneur who is trying to determine the efficient and sustainable direction of resources, including the allocation of capital goods. It spends according to economically irrelevant criteria of job creation, propping up over-expanded sectors, and preventing politically painful adjustments.
Such spending is counterproductive in the medium to long term. It is also unsustainable (once the stimulus stops) since it is not consistent with the preferences of consumers-savers-investors.
These considerations tell us that government spending isn’t equally as good as private. To argue otherwise, I suggest, is a mark of basic economic error.