Swan ‘s economics a doomsday formula

It’s a truism of Keynesian economics that consumer spending drives the economy; if spending slows in a recession, government must make up the difference. In reality, consumer spending merely signals what consumers want; producers may be unable or unwilling to deliver. Government spending may compensate — or make matters worse — depending on the type of spending and whether it’s financed by progressive taxes or by borrowing.

Let’s see if I can explain it:   I go and spend $1 at the shop. The proprietor spends $.80 of that for petrol. The petrol station owner then spends $.80 of that to get their hair cut and so on.  By the logic of what is an infinite series,  my original $1 in spending has created an additional $4 dollars in spending; or a “multiplier” of 4.  And with that additional spending comes another $4 in production.

Now imagine if I leave that $1 in the bank, and the bank doesn’t lend it to someone else to spend, then government must spend a $1 instead to keep the economic machine running. This is the idea behind Keystone Cop accounting, and it sounds fair doesn’t it?

But, there is a glitch in this philosophy: the assumption that spending automatically leads to production and jobs.( this is where we must remember what it means to Ass u me.)

Consider a small business. It makes wooden widgets. Every month it has to decide how many puzzles to make, and in essence  how many hours to schedule for it’s employees. So what will it consider?:

1. First, it must estimate the next month’s sales from the sales last of the last month as well as the trends of previous months.
2. Therefore it plans how many widgets to produce based on consumer spending. But also considers how much cash is available to pay for plywood and workers’ wages.
3. Small businesses will often operate on lines of credit, borrowing each month for payroll and materials, then paying back loans with cash following sales.
4. If — as happens in a recession — banks reduce the amount of credit and customers delay paying, our widget maker cuts back planned production and lays off it’s workers.

If it were a large profitable conglomerate, an combination of dozens of businesses and thousands of products. This kind of enterprise faces no shortage of cash in a recession.
But management will become very cautious.  It shuts down it’s less profitable business lines and lays off workers, even though there may still be substantial demand.
Equally big banks turn cautious, denying credit even to it’s steady customers like our widget maker.

Therefore when a recession makes cash tight for small business, and confidence low for large business, consumer spending does not necessarily translate into production and jobs.

Can government spending create production and jobs to replace those lost in a recession? That would depend on the type of spending. Military spending is the hardest. First it creates very few jobs per dollar spent; second, it creates limited benefits. Although it is much needed and we cannot afford to make it too lean.  Contrast that with urban services:  street and sewer repairs, garbage collection, schools, police, fire, welfare and health provision — all of which create many jobs per dollar spent. Then add to it Federal safety-net spending – ie. Social Security, & Medicare.  Without these services operating invisibly in the background, neither the Widget maker, the conglomerate, nor their customers would survive.

This is where I believe government should spend more money during a recession, not cut back.  The effectiveness of government spending also depends on how it’s financed. Local government services raise property values; when property owners pay property taxes, they pay for benefits received. However excessive borrowing undermines the benefits of government spending.  It is really a harmful myth that spending drives the economy. It makes us think we can rev up the economy by any additional government spending, financed by borrowing. In reality, we need productive, job-creating, service-providing government, supported by sensible taxation that does not take away the incentive to create business in Australia.

Wayne Swan ‘s Keynesian Accounting has cost us $232 billion debt at a time when we should have been building business confidence in Australia.