Should the government increase spending to get out of a recession

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Last updated: April 19, 2019

A recession is a terrible thing. Unemployment rates soar as firms close down, economic growth slows due to a lack of demand, and with consumption declining, desperate consumers seek help from the government to sort the economy out. One method of doing so involves a hefty fiscal stimulus, known in the trade as ‘government spending’.An increase in government spending was a method famously proposed by arguably the most influential macroeconomist of the twentieth century – John Maynard Keynes. His policies became known as Keynesian economics, and have notably been implemented in 1937, to assist Franklin Roosevelt’s New Deal program during the great depression1. Keynes argued government should exploit its massive financial power to force the economy into submission and encourage economic activity2.

Keynesian economists call this theory “counter-cyclical demand management,” because it attempts to effectively control aggregate demand3.How, then, does this theory work? Government spending consists of public sector pay, publicly provided goods (such as defence and the NHS), transfer payments and debt interest4. An increase in transfer payments – money taken from the rich, and given to the poor – will increase demand for the necessities in life, such as food and water. People on low incomes general have a high marginal propensity to consume, because more of their income is spent on goods and services need to survive5. Whereas the rich can safely have idle money in bank accounts, gathering interest, and still enjoy luxury goods like that new Mercedes Benz. Therefore, the accumulated revenue from taxation can be used to fund the lives of people on low incomes, in true Robin Hood style.

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However, I sense a problem. The government does not have an infinite supply of money or materials, because as the basic economic problem states “there are finite scarce resources to satisfy infinite wants” 6. There are three main ways the government makes its money, discussed below7:* Taxes (indirect and direct), levied on income and consumption (e.g. VAT and excise duty),* Borrowing from other governments,* Printing more money – coined ‘quantitative easing’.Therefore, in order to fund a government proposal, the necessary revenue has to be generated. You can’t buy a 30p apple without 30p8. The problems that arise from this are substantial.

If the government raises taxes, ceteris paribus, consumption will decrease, as consumers have less discretionary income. The method seems counter-productive – why lower people’s real income to bring the economy out of a recession? This perfectly complements the argument that governments should not increase spending. In addition to the aforementioned problem, borrowing money seems like a viable alternative. Buy now, pay later. Increase economic activity now when it is direly needed, and pay later when the economy is healthy9. This smoothing out of the business cycle is all well and good in theory, but in reality there are too many variables to account for, and it is not as simplistic as this model10.Looking at the views of professionals can prove highly insightful.

Barack Obama disagrees, and argues for an increased in government spending to soften the blow of an economic downturn11:”The recovery plan and the financial stability plan are the immediate steps we’re taking to revive our economy in the short-term. But the only way to fully restore America’s economic strength is to make the long-term investments that will lead to new jobs, new industries, and a renewed ability to compete with the rest of the world. .

.. history tells us [that] government [shouldn’t] supplant private enterprise; it [should] catalyze private enterprise”That’s the most powerful man on the planets view of the matter12.

Long-term investment in human capital and enterprise is the way forward – apparently. This seems like a logical hypothesis: donating money to provide jobs in the long-term well increase overall job security, if there are more jobs. Plus, the skilled labour needed to construct new building, transport and infrastructure creates temporary jobs in the short-term also. Mr Obama also draws on the historical elements of Keynesian demand-management as a policy to draw an economy on of a recession. The private sector is more much efficient than any, because of the profit incentive driving innovation and businesses constantly forward. One can conclude Mr Obama has hit the nail on the head seeking to encourage private enterprise, but there is another, more effective way of doing so – lower corporate taxation13.By lowering taxation, the incentive to an entrepreneur thinking of setting up a proprietorship but has not done so due to the off-putting nature of losing a proportion of profit to the government is drastically increased14.

In order to promote competition and achieve efficiency in the market, the aforementioned quasi-fiscal/supply-side policy must be implemented. Small business growth is a key driver of economic growth15. Granted, globalised businesses provide a healthy source of employment across the world, but with their monopoly power, they can control the labour market by exerting dominance in harsh time16. The fad of ‘McDonaldisation’17 provides jobs for over 1.5million people18. Unfortunately, the negative externalities arising from over-consumption of demerit goods is a source of market failure – and a Big Mac may well be labelled a demerit good19. Then there are the ethical issues attached with globalised business; the rich gain at the expense of the poor20. Localisation provides domestic jobs, consumer choice and directly contributes to real GDP, which is only advantageous.

Small businesses do not tend to have the large expenditure needed to operate globally, and this henceforth backs-up the view that supporting small businesses with finance and information is better than providing monopoly power houses with the fuel needed for utter market dominance.The government should not increase spending. The government should be more lenient on the private sector allowing growth and promoting strong competition. The need to generate more revenue to inject back into the economy is now obsolete, and jobs are still being created in ample quantities, allowing more cyclically unemployed individuals to break free of their minimum income lifiestyle21. I for one, fully back the conclusion that this policy will be ultimately more effective than any (feasible) amount of government spending could ever achieve.

A king once joked when liaising with his jester22:”Jester, bring me an economist with one hand.””Why, sire?””Because economists always say on one hand it could be this, but on the other hand it could be this. And I want a definitive answer.”Humour over, this quote has much significance in modern life. If one seeks help from an economist, it is likely a variety of answers will follow.

We have already seen one alternative opposed to government spending as a method to get the economy out of a recession – more relaxed taxation rates. There are a number of alternatives though, which in total cannot be counted on two hands, here are the main ones23; increase consumer confidence, expansionary monetary policy or as free market liberals would argue, just leave the economy to its own so the market forces and supply and demand will reach equilibrium. Different policies are favoured by different economic schools of thought24.Overall, the argument that government should increase their spending to get the economy out of a recession solely depends on the government in power.

In the global recession of 2008/2009, the Labour Party in the UK supported such monetary stimulus25, but the estimated time for the changes in consumer spending to actually to be noticed is around 8 months26. 8 months is a long time. By default, this means the economy would experience an economic downturn from the time the policy had been enacted, to the time for the effects to seep into the economy at least – assuming something is done straight away. The unemployed who came to the government for help in the first paragraph have lost all their confidence in the economy, and therefore the balance between expansionary fiscal policy and the lack of confidence in nullified.This alone is evidence that the government should not solely rely on spending to kick-start economic activity.

It needs to lower interest rates, assure consumers the economy is not in serious trouble too27. Conversely, governments need not to run a budget deficit at all. Basically, cutting interest rates will lower mortgage payments and improve the incentive to borrow and invest28, thereby increasing disposable income and throughout the accelerator effect, fuel investment levels29. Surely this policy is better than the volatile, medium-term effects of inflationary fiscal methods. Ultimately, the government should rely on ‘safer’ more effective options opposed to increasing spending, as monetarist and supply-economists will agree.

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