By now, we’re all accustomed to talk about government action “stimulating” the economy. I wonder, though, if we give enough thought to how this can possibly work: How can government increase economic activity above its natural level — and why, if it can do so, doesn’t it do this all the time?
Stuff
When we talk about “the economy” in terms of whether it’s doing well or poorly, we’re usually talking about how much stuff is being produced. To grossly oversimplify: When an economy is doing “well”, it’s producing lots of stuff, and when it’s doing “poorly”, it’s producing less stuff.
Now, this is a distorted view of the matter, for (at least) three reasons:
- You’re really interested in per-capita stuff; it’s output per person that (roughly) determines quality of life
- People expect things to get better over time, so the amount of per-capita stuff produced every year needs to trend upwards to keep people happy
- It’s all relative; a great per-capita level of output for one economy (China) would be catastrophic for another (the U.S.)
But, as a rule of thumb, “healthy economy = lots of stuff created” is a serviceable one.
Paradox
When politicians talk about “stimulating” the economy, what they are actually discussing are actions designed to result in the creation of more stuff. This raises the question: Why weren’t these policies in place already? Politicians tend to get re-elected when people are happy, people are happy when the economy does well, so why don’t politicians always see to it that the economy roars along?
Obviously, the answer is that they can’t. Governments are essential to the smooth operation and growth of economies. However, most of what they can do they have already done in a modern Western economy: they have provided a system of stable, predictable laws, enforcement of contracts, and physical protection through national defense. If these things were not being provided, then of course politicians could stimulate the economy by providing them — but once they exist, there isn’t much to do. Political meddling can actually be counterproductive; for example, an expansive, arbitrary, regulatory/administrative state that introduces capriciousness and unpredictability into governance would tend to suppress economic activity.
Politicians who wish to “stimulate” the economy are therefore trying to do something that they don’t know how to do. Their position is not unlike that of the management of an underperforming company looking for some way — any way — to boost its quarterly earnings numbers, but who have no idea how to legitimately do this.
Margin
Permit me a brief digression into marginal utility. Utility is an economic concept that captures, in an abstract sense, how much benefit someone gets from something. Since people seek to maximize net benefit, they will keep doing something until its marginal cost exceeds its marginal utility. “Marginal”, in this context, refers to the cost or benefit associated with the last unit of something: the last ice cream cone bought, or the last hour worked.
How can politicians induce people to produce more than they would otherwise? Well, people produce goods so long as the marginal utility of either the goods themselves, or other things obtained in trade for them, exceeds the cost of their production. Politicians, therefore, have to arrange for people to get more utility from the goods that they produce than they otherwise would, so that people will have an incentive to produce more stuff.
Now, this is a tricky problem, because politicians don’t have any money of their own. If politicians arrange it so that some people get more for what they produce, it often follows that someone else gets less. For instance, if politicians attach a subsidy to tractors, then more tractors will be produced and sold — at a slightly lower price, with the subsidy bridging the gap between the new lower price that consumers must pay if they are to buy more, and the new higher price that producers must see if they are to create more. However, the money for the subsidy must come from somewhere, and if it is raised through taxes, then the government has reduced the marginal utility of the taxed good to whoever was producing it — this will counteract the supposed stimulative effect of the subsidy.
Promises
On the other hand, politicians are great at making promises, and this is what fiscally stimulative policies amount to; politicians promising people that if they create more stuff today, then the government will pay them an above-market price for it tomorrow. It’s more complicated in practice; the government is actually paying (directly or indirectly) above-market prices today with borrowed money — the promises are being made to the lenders — but the principle is the same.
The problem with this is that those promises eventually have to be paid for, and the taxes required to do so will represent a drag on the economy in the future. The more exorbitant the promises, the more serious the drag. It’s a kind of temporal thievery, really.
