What Happens in a Bad Economy?

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    Politicians like to talk in abstractions.

    Come to think of it, they like to argue and obfuscate in abstractions, as well. They campaign in abstractions and make abstract pledges until those abstractions turn into something tangible, like a subprime lending crisis or a downgrade from a particular private rating agency.

    We spend so much time wading through abstractions that we cannot get to the meat of the issues that face us today. Enough of that.

    What really happens in a bad economy? And what is the public’s role during these tough times?

    Americans feeling the pinch have less disposable income–their paychecks go in increasing amounts to paying the bills and saving to make ends meet.

    This means there is less overall consumer spending. Sure, certain industries do better–oil & gas, for instance–because they are pseudo-required for transportation to and from work or school.

    Less consumer spending means lower demand for durable goods (automobiles, clothes, household appliances, etc.). This lower demand results in lower prices for these goods (or even a forced lower supply).

    Lower prices & lower supply means businesses bring in less money and potentially less profit. This means big-time layoffs and a plethora of pink sheets.

    Fewer workers and fewer wage jobs further decreases consumer spending, even though prices have lowered. This drives that vicious circle even farther, resulting in even greater job loss.

    All of this illustrates what we can call the “paradox of thrift:”

    “By attempting to increase its rate of saving, society may create conditions under which the amount it can actually save is reduced. This phenomenon is called the paradox of thrift….[T]hrift, which has always been held in high esteem in our economy, now becomes something of a social vice.”

    Pundits are fond of saying that “if a family operated its finances like the federal government, they would go bankrupt!” This is true, from the whole to the individual unit in society. But the revered Adam Smith wrote, “What is prudence in the conduct of every private family can scarce be folly in that of a great Kingdom.” The implication that spending in the federal government is wrong or evil is false; it’s a “fallacy of composition.”

    What does that mean? “If a population saves more money…then total revenues for companies will decline. This decrease in economic growth means fewer salary increases and perhaps downsizing. Eventually the population’s total savings will have remained the same or even declined because of lower incomes and a weaker economy.”

    So what is the role of the public–through their government–in these tough economic times?

    Government spending bridges the gap–while the overall propensity of families across the nation may be to save, public investment slows the contraction of the economy due to that subsequent lower demand we talked about earlier. Government spending helps individual families do what is economically prudent according to their own circumstances, without unnecessarily dragging down the national economy.

    In other words, when you and your family are focused on spending, you can’t help grow the economy through your usual spending and investment. That’s where public investment is pivotal–and has historically brought us through rough patches.



    Of course, this argument presupposes that in good economic times, government–as a matter of course–spends less; this did not happen from 2001-2008. Unnecessary government spending on programs with no long-term benefit to the American public–the Bush-era tax cuts and spending on two major wars–drive up both deficits and explode the national debt. That is what has driven the current debt/deficit reality.

    (And for those worried about raising taxes on families in tough times–I certainly am–let’s simply let the Bush tax cuts expire already. They cost the country a whopping $1.8 trillion, contributed to the housing bubble and did not achieve growth. They did the exact opposite of what a responsible government does when the economy is strong; instead of running a surplus and paying down the debt, they ran up needless deficits and exploded the national debt.)

    (Cross-posted from The Journeying Progressive.)

    • Redjek

      What you have stated is the root of Keynesian economics.  Unfortunately, our politicians are not Keynesian, in that they do not take out of the economy when things are going well, so that they can tap into that when things are going bad.  The closest we have is Virginia’s “Rainy Day Fund,” which seems quite inadequate now.

      One-sided Keynesian economics cannot work, because without a Rainy Day Fund on which to draw, the government must take money out of the economy, through increased taxes or borrowing, so that it can put it back into the economy.  They are trying to fill the bathtub my taking water out of one end and putting it into the other.

      To say that the Bush Tax Cuts did not increase growth is to deny the facts.  After the 2003 Tax Cuts, which reduced Capital Gains Tax rates and Dividend Income Tax rates, revenue to the government increased for the next four years, and the deficit to GDP ratio declined from 3.48% to 1.14%.

      When the Democrats took Congress in 2007, they increased the deficit-to-GDP ratio to 3.19% in FY08, and to 10.01% in FY09, even though both years had higher GDP than FY07.

      http://www.usgovernmentspendin

      Both FY08 and FY09 also saw more REVENUE going into the government than in FY07.

      http://www.usgovernmentrevenue

      In FY08 and FY09, revenue to the government was higher than in FY07.  GDP was higher, too.  But the increased spending outstripped them both.