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A brief philosophical argument about the role of government, stimulus and recession

I was chatting with Marshall Auerback about some of my recent posts on Keynesianism and Austrian Economics — Marshall is a post-Keynesian — and he convinced me that my posts were somewhat misleading and that I had only presented half of the argument for stimulus. This led me to thinking about the role of government, stimulus and recession which I felt compelled to present here.  Your comments are appreciated.

Government is redistributive

Let me start my argument this way: Government, by its very existence, is always redistributive. Therefore, a key role of government is to redistribute income. This statement is self-evident to some, but provocative to many. So let me explain why this is so.

Most reasonable people would agree that a large society requires government to maintain order, provide basic services and assemble military defenses. These are all considered basic roles of government. However, to take on these roles, government requires funding and this means taxation [in a fiat currency system, not to fund its spending but to give its currency value]. Now, taxes, by their very nature, are redistributive. Levying a tax on one person or one good takes money away from that person or that business and puts it in to the common pot. This is the definition of redistribution. Government cannot function without taxes and taxes are by their very nature a redistribution of income from some agents to others. Therefore, government is a naturally redistributive agent.

To my mind, the redistributive nature of government is obvious. In fact, it struck me as extremely disingenuous during the U.S. election this past year when John McCain led the Republican Party in admonishing Barack Obama for suggesting he was going to “spread the wealth” — as if that’s not axiomatic.

The real question is this: Because government must tax to maintain its existence or to ensure its control of the currency and this tax will redistribute monies from some agents to others, what are our priorities as a people as to how that redistribution should take place? Who should we tax, by what means and by how much? And who should receive the benefits of government spending and for what purposes? These are questions actually worthy of debate and are fundamental to democracy.

My answer is fairly straightforward: how we tax and how we spend government money depends on the economic, political and military situation, on the wisdom of our leaders and on the priorities of the people. There is no ideological answer to this question. One problem I have with the small government crowd is the ideological view that the answer must always be the same regardless of the circumstances we face. I certainly believe very much in limited government. I think most people would label me a Libertarian or a fiscal conservative. However, I am not ideological. I am pragmatic and I believe public policy must adjust to the specific requirements of the time.

I would add that limited government does not necessarily mean we should forgo universal health care for example.  It is often argued that we need to get back to the days when government was smaller and America was a much better country.  When was this? The last time I checked America was a much richer nation than it was in 1900 or 1950, or whenever those who want to return to the past are arguing. Do you really want to go back to 1900 when we had no safety net in America?  I believe the lack of a social safety net is a major reason that the Great Depression was such a human trauma for the United States.

Moreover, government expenditures are less than a quarter of GDP in the United States today.  It is much larger in Europe.  It seems foolhardy to me that the so-called richest country on earth could allow tens of millions of its citizens to live without guaranteed access to free basic health care.  What is the point of being a rich nation, then?

These are the questions that any democracy must answer regarding how it reallocates its resources through the taxing power of government.

Stimulus is necessary and warranted

This leads me to the question about stimulus. Where Marshall has a problem is with this statement: “So, my thinking is fairly simple: cushioning the fall with government stimulus will prevent worst-case outcomes — nothing more. It will not prevent depression.” from my post “What does Mises say about trying to stimulate the economy out of recession.” This statement focuses entirely on the recession and not at all on the recovery. It looks like this:

recession-path-down

when it could look like this:

recession-path

So, I would say this: in the absence of stimulus, the present global downturn would be much more severe. In fact, it could threaten systemic collapse — a rupturing of our entire financial system if allowed to continue without some measure of countervailing monetary and fiscal stimulus. Moreover, stimulus is likely to speed recovery. Therefore, stimulus mitigates worst-case outcomes and speeds recovery.

My argument here looks like this:
recession-path-comparison

As to what form this stimulus should take, I will leave that argument for another day.  I do feel that we need to invest in health care, education, energy and infrastructure.  Obviously, massive stimulus means deficit spending. And I would anticipate this deficit spending to last many years, leaving a mountain of debt. However, the speeded recovery will be quite helpful in defraying the burden of that debt. And, let’s not forget that the alternative could be collapse.

recession-path-collapse

The purpose of recession

My final argument involves the purpose of recession. In my view, policy makers, especially in the Anglo-Saxon world have long felt that avoiding recession is an important goal of economic policy. However, that view is misguided because it has led to an asymmetry whereby stimulus is applied in much greater amounts to end recession than to stop overheating. This asymmetry, often called the Greenspan Put when Alan Greenspan was Federal Reserve Chairman, is directly responsible for the build up of debt, leverage, over-consumption, and current account deficits in many of the Anglo-Saxon economies.

While painful, recession serves a useful purpose. It purges the excess of the preceding period. Avoiding recession leads to bubbles and bubbles lead to systemic risk and depression. It is far better to allow the recession to occur, mitigate its effect if necessary through limited fiscal or monetary stimulus than to risk a depression in which massive stimulus is necessary.

Those are my arguments. I would appreciate hearing yours.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

7 Comments

  1. cynic says:

    the term redistributive has deeply socialistic connotations, especially when coming from someone like obama, and within/after the roiled political atmosphere of the bush administration. While its true taxation takes from all to allocate funds for acts that benifit the whole the impressions of late is that our money has been siphoned off to private contractors with connections, friends of hank, pork barrel programs and other gross improprities.

    on a side note..I support universal healthcare because lawyers, insurance fraud, and insurance companies have crippled the industry. Their first step should be to punish frivioulious lawsuits, and provide thousands of free ride scholorships to medical students to swell the ranks and lower doctors wages. However i have little faith in the govt doing anything the right way where politics and special interests can benifit from the rape of the people

    which of course brings us to the bailout…recession is mandatory. depression may be mandatory. debt levels were unsustainable. asset prices inflated. bailout powder is being blown on trying to maintain the facade. healing will not happen until confidence is restored. accounting tricks, level 3 assets loss hiding, false colloratal for fed loans, book cooking will not help, just ensure our downfall. powder being burnt as we speak.

    waste, pork , and corruption is all i see. the empowered feasting while rome burns in teh background.

  2. @cynic,

    welcome to the blog. redistribution is seen in certain circles as code for taking what should be mine and giving it to someone who doesn’t deserve it. we should avoid that interpretation and see government and taxation as naturally redistributive. that makes obama’s comments seem much less sinister.

    when you talk about siphoning off money, I take it to mean special interests and this is the real problem with redistribution. I’m all for a debate about how we should be taxed and how that tax should be spent. what I am not happy about is some special interest group using money and influence to shift monies to their benefit.

    As for recession, it is painful but necessary. getting rid of the excesses you mention will put things on a much sounder footing.

  3. John Creighton says:

    To me a redistributive tax policy means stealing from the rich and giving to the poor. Since the rich pay most of the taxes, the poor see social services as essentially free and thus may demand a size of government which is overly burdensome and hard to sustain. That said I think a negative income tax system would be better then a welfare system.

    I’ll accept that stimulus can ease the cushion the blow but I’m not convinced it will speed the recovery. A large stimulus package means an increased taxation burden on the upside. It also means that their will be less weeding out of the less productive business (economic Darwinism) during the downturn. Some people (e.g. Ron Paul) say that the bailout will only make the recession longer. To me the alternative to the bailout/stimulus is worse but I believe intervention on the downside is necessary to this degree largely because of bad monetary policy on the upside.

    • @John Creighton, we agree regarding stimulus to cushion the blow on the way down. On the way up, it remains to be seen whether stimulus will quicken the recovery. I am of the view that it will. However, that is a contentious issue that will be difficult to resolve. But, at a minimum, stimulus will prevent worse case scenarios on the way down — that much we can agree on.

      With regard to redistribution, I’m glad you responded. It is very much an argument that goes to the core of one’s belief system and is therefore fraught with emotional investment. But, looking at the issue more dispassionately, I tend to feel that the status quo is self-perpetuating and breeds a “feeding at the trough” mentality. Therefore, I am keenly aware of the need for government to reduce the reinforcing nature of the status quo. I am of the view that this past quarter century clearly demonstrates this “feeding at the trough.”

      Ultimately that is bad for society as it breeds resentment and leads to a violent pendulum swing in the other direction. When you say it’s about soaking the rich, that is an ideological viewpoint that invites an equally ideological response. I would argue that it would be more beneficial over the long-term to realize that some redistribution will occur and one must work to ensure that it does not become excessive.

      Comments?

  4. John Creighton says:

    If we look to government to break from the status quo are we fooling ourselves? Aren’t governments self perpetuating institutions? Doesn’t the fact that the government regulates media and controls education help perpetuate a conformity of opinions and a reward for meritocracy? Isn’t it competition that helps foster excellence and promote our own strengths and individuality? Shouldn’t we rather look for government that gives freedom to break from the status quo instead of one that trys to promote whatever new view fancies the politically correct ideology of the elite of the time? The most fundamental freedom is the freedom to think freely. That comes from us making our own choices instead of the government planning our lives.

  5. Hal Horvath says:

    I think of the stimulus as buying time (against a collapse), and do not expect a general recovery in the US *unless* sufficient *new* types of business arise. In short we need a new direction in the economy. At the end of WWII, there was much new technology ready to be brought into consumer products, for example.

    On the other hand, if miraculously the Chinese peg to the dollar ended, then we could have new manufacturing jobs of course, which would help some.

    This kind of question is the real issue at this point.