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February 08, 2009

America Will Pay a Heavy Price for Obama's Economic Illiteracy
by Gerard Jackson

The idea of any economic stimulus package is to get an economy moving. This is not as simple as it sounds. That an economy can be stimulated and yet go backwards is a thought that does not seem to have occurred to the economic commentariat. Allow me to explain. The prevailing error is confusing increased spending and a rising GDP with increased economic growth. But as any economist ought to know, economic growth is a process of capital accumulation. From this it follows that any program that specifically targets consumption or focuses on what is termed shovel-ready projects will retard if not actually paralyse economic recovery.

There is certainly more than a glimmering of the recognition of this fact in the Congressional Budget Office. (The rumour mill has it that Democrats want to stack this estimable non-partisan bureau with their partisan stooges). It recently reported that Obama's so-called stimulus would have the long-run effect of crowding out private investment and so lower the rate at which GDP will grow.

I have a great deal of respect for the CBO. It is run by honest and highly competent people whose integrity is beyond reproach. Nevertheless, its most basic -- in my opinion -- is that it is staffed by people who adhere to the orthodox view that GDP is a fairly accurate measure of economic activity. Although I realise I am in danger of being accused of beating a dead horse here, allow me to once again stress that with consumption at about 70 per cent of GDP total economic activity comes in at more than twice the GDP figure.

This is because the national accounts ignore all intermediate spending. Therefore we conclude that it is business spending, i.e. Investment and savings, that needs to be stimulated, not consumption. The thoroughly sensible view that consumption springs from production and that it is the latter that needs encouragement if living standards are to be maintained let alone increase was a basic tenet of classical economics, which John Stuart Mill expressed eloquently when he wrote:

What a country wants to make it richer, is never consumption, but production. Where there is the latter, we may be "sure that" there is no want of the former. (John Stuart Mill, Essays on Economics and Society 1824--1845, Liberty Fund, 2006, p. 263).

Like it or not, to get a fairly good grip on why the Democrats' stimulus package and Obama's deep rooted hostility to tax cuts are so damaging one needs to get some understanding of the fallacious thinking being used by some economists to justify this so-called economic program. It is based on the assumption that the US is a two-stage economy. There is a production stage and a consumption stage. It logically follows from this view that the maintenance and supply of capital would depend entirely on consumer demand. It also follows that the case for consumer spending to promote economic recovery rests on the equally fallacious belief that recessions are produced by underconsumption.

However, we in a world of multiple stages of production. It can be no other way except under the most primitive economic conditions, the kind that would prevail among stone-age nomads who live a precarious existence on a day-to-day basis. The logic is therefore ineluctable: any policy that reduces spending between the stages of production by redirecting it to consumption will prolong a recession. Under these conditions one would find that consumer spending would rise relative to total business spending and that unemployment in the higher stages of production would also rise relative to those stages of production close to the point of consumption. This is precisely what happened during the disastrous Roosevelt administration. In 1934 it was estimated

that of a total of almost 14 million persons were without jobs at the peak of unemployment in March, 1933, 6½ million were from the durable goods industries, nearly 6 million were from the "service" industries, and only 1½ million were from the consumption goods industries. Investment activity, in a word, is the tail that wags the industrial dog. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 235).

There can never be any genuine understanding of what happened during the 1930s without a firm grasp of Austrian capital theory, painful as that must be to Obama's Keynesian supporters. Only a sound capital theory in conjunction with the recognition that money is not neutral can explain why Roosevelt's New Deal was a dismal failure.

Despite the lessons of history and the fact that he is a proud member of the "reality-based" community Obama and his advisors are total economic and historical illiterates who suffer from a big government fetish. Unfortunately, their addiction to big government will carry a heavy price for the American people.

Democrats are already screaming that I am being "grossly unfair" to The One Who Must be Obeyed. I am no admirer of cults and I find the Obama cult particularly offensive because of its brazen hypocrisy and the vicious way in which it treats its critics. Regardless of the hysterical bleatings of his disciples, Obama is an empty suit, something that is now becoming rapidly apparent to many Americans.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2009 Gerard Jackson

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