Regular readers will be aware that on the topic of austerity, I generally agree with John Maynard Keynes:
The boom, not the slump, is the right time for austerity at the Treasury.
Regular readers will also know that I like Ron Paul — a Presidential candidate who promises a $1 trillion spending cut in his first year in office.
Is that a contradiction? I don’t think so.
Why?
In comparison to most austerity-stricken nations, the United States under Ron Paul would be a special case, for one key reason.
Ron Paul’s cuts — rather than destroying productive output like Brüning in the 1930s, or Papandreou today — are aimed at cutting the two greatest wastes of productive output: financial sector corporate welfare, and imperial military spending.
This topic cuts to the heart of the Keynesian and Rothbardian views on recessions in general, and depressions in particular.
Essentially, the Keynesian position (and its later monetarist adaptation) is that a slump in aggregate demand (i.e. GDP) is — for whatever reason — the problem, and that this can be remedied by the government doing whatever it can to raise aggregate demand (Keynesian stimulus, quantitative easing, nominal GDP targeting).
The Rothbardian position is that the problem is caused by government-led malinvestment, and that the junk must be allowed to liquidate before an organic recovery can ever take hold (zombification).
Both views have something to them, but both views overcomplicate the problem. The real issue is the drop in productive output.
As I have shown before, it is perfectly possible (and actually quite common) for monetary and fiscal policy to raise or stabilise aggregate demand without actually addressing the underlying productivity issue — leading to superficial (and hollow) recovery, like Japan in the 90s and (probably) America today.
Austerity policies during a recession can often totally choke off productivity (Brüning, Papandreou, etc). This is particularly true in nations that are very centralised, and where government has become a very important economic actor.
Now Austrian economists may say that government spending is always a misallocation of capital. Well, I agree that central planners lack the information of the free market. But government is useful in supporting underlying productivity (as Adam Smith noted) through infrastructure creation, the rule of law, etc, and withdrawing that support during a slump for the purpose of paying down debt is detrimental.
So the key here is that government should do what it can to support productivity. What the Keynesians (and monetarists) got wrong is the idea that aggregate demand was somehow a good reflection of underlying productivity, and that underlying productivity can be effectively supported with money pumping, or by digging holes. My model is that the best means to sustain and increase underlying productivity is that government should let failing economic systems completely fail, end wasteful and capital-destroying activities like imperial adventurism, and recapitalise the broader people of the nation. Ron Paul’s aim of cutting taxes and simultaneously cutting military adventurism and corporate welfare would do that. His policies are not the austerity policies of tax hikes and spending cuts which constrict the economy by sucking money out to pay down creditors without putting anything back in.
azizonomics 
The US government spends nearly 18% of GDP on healthcare.
And 6% on military adventures.
Paul might cut the second, but he;s going to have to butcher the first as well.
US medical system is a corporatist uncompetitive disaster, and a lot of that “healthcare” spending is actually administration and bureaucracy costs that are smaller even in a socialist system (in many ways, the US federal system is the worst of socialism and the worst of the market). But the official figures are somewhat of a smudge. Here are the figures I use — and by these figures, the real problem is past and present military adventurism:
https://azizonomics.com/2011/08/02/the-problem-with-spending/
RP recognises you can’t quickly cut programs for individuals and families that the gov’t has made dependent. Firstly you have to honour programs for the elderly and disabled who cannot make other plans. And for those of working age, you have to wean them off. Otherwise you get social disorder. That’s the danger of creating dependency, and removing such programs during a depressed economy with no engine of growth to pick up the slack is totally self-defeating.
For “needy” corporations you can more quickly slash and burn and let the free market and creative destruction pick up the slack.
http://www.usgovernmentspending.com/
I was pulling from there, although I quoted the wrong numbers, Defence and Health care are 5.2% and 7% of GDP or 15/18% of government spending.
Defence makes up 15% of government spending.
Even if RP abolished the military, he wont achieve his goal.
President Paul would be involved in the Federal budget, where defense makes up 25% of the headline spending (http://www.usgovernmentspending.com/fed_spending_2011USbn) and significantly more if we include pensions on past wars and interest on war debt. The total military-industrial-complex-related federal expenditure is given in the article I first posted at more than 50% of federal expenditures (https://azizonomics.com/2011/08/02/the-problem-with-spending/).
The problem is war and weapons spending and however the military-industrial complex dress up the figures that is just a fact. I don’t dispute a lot of waste and bureaucracy (particularly on healthcare) needs to go, but we can’t solve the spending problem without recognising who is really parasitising the taxpayer, and destroying America’s national security with needless debt-creating, terrorism-provoking, infrastructure-destroying, productivity-wasting wars and occupations.
@Azizonomics, Do you believe the Keynesians are ready to admit that the national debt does matter? In the face of the European mess, how can they not? What logic do they use and how do you refute their arguments?
Well Paul Krugman who is generally held as a paradigm of Keynesianism holds that debt is a problem, he just believes that the current low interest rate situation (and forecasts he gets from Hicks’ IS/LM model) to suggest that now is a good time to borrow much more to stimulate organic growth, which he believes is being shuttered off by low demand.
My refutation of this is that low demand is not a problem in itself but a symptom of some deeper problems:
1/ The abolition of deflation, which has allowed for the accumulation of vast quantities of debt
2/ American oil addiction and a lack of developed alternatives to oil/ oil infrastructure.
3/ Exotic derivatives & systemic fragility — a house of cards that will one day come crashing down due to an institution (or nation) being too big to fail and too big to save.
4/ The artificial housing bubble that existed before — a vast credit bubble that pumped prices up unsustainably.
There is no guarantee that more stimulus money will address any of these problems, and in fact will probably exacerbate them as the first rounds of monetary and fiscal stimulus did.
All Keynesian stimulus is guaranteed to do is hide the problem for a short time before it re-emerges. This is often in a worse form.
In fact I have some pretty strong empirical evidence that inflationary solutions have little or no overall impact on debt minimisation…
As to point #3, what is the role of regulation in your opionion. If “too big too fail” and the resultant “bail-outs” were taken off the table, would this alone be enough to reign in future bubbles? I see the problem as this: Regulation doesn’t work well because politicians (Keating 5 for example) over-ride the regulators. Another example would be the fraud committed by Madoff. Another investment broker easily spotted the fraud (mathimatically/statistically) but because Bernie had been an SEC chariman, nothing was done. What role do you believe government regulation should play in the financial markets?
I agree with the SEC mission statement:
The problem is, it doesn’t work out like that. Firstly, I think the nature of the financial system should prevent (or severely limit) credit contractions, because it is this that makes institutions TBTF. If that means full reserve banking, or much lower reserve requirements then so be it.
When it comes to fraud, I like the Chinese model:
They execute billion-dollar (and even million-dollar) fraudsters like Madoff and (allegedly) Corzine.
http://www.thechinamoneyreport.com/2011/11/20/china-applies-five-finger-death-touch-to-another-business-fraudster/
Possibly I don’t agree with execution, but very, very severe and humiliating punishments.
If we don’t do monetary and fiscal austerity in boom times, is there another time it can be done, or are we literally doomed?
It is much easier to do fiscal austerity when the money supply is not debt based. Under the current system, the only time when it will not be productivity crushing is once the system has cleared itself out and stabilised and is growing again. Then you can peel it back.
The real secret is to not take on the spending in the first place.
I love 75% of what Ron Paul proposes but the other 25% scares the heck out of me.
I see the economy as bland for years to come if we do not clear the bad debt. This would seem much more a political question than an economic one. We need someone to enlighten America as to where we stand: Trillions of unfunded liabilities and an ever growing national debt. Between maintaining an empire abroad and outspending China 7 to 1 on the military, then having to turn around and borrow substantially from China – we need a sane fiscal and monetary policy. It is up to the economists to debate in large measure. However, it would appear that Keynes was not wrong about stimulating the economy in down periods; only in that the government cannot be expected to contract after such a period has passed. There is much more to economics than equations – as I remember complaining to my Econ profs many years ago. In the good times the spending only increases. After all, they are the good times.
Clearing the balance sheet will be a shock to the system. But one that will pave the way to a new prosperity. The only true safeguard when it comes to keeping the markets honest is certain failure for making a big gamble that goes bad. Taxing the middle class and the poor by inflating the dollar only hinders our recovery. Spending by the federal government is always a tax. Someone must pay.
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