A growing number of economists are predicting the current economic boom will turn to bust in 2019. When recession does come, will economists simply call for more of the same — namely endless government spending?
After all, in the wake of the 2008 financial crisis, most economists told us the problem was the private sector was not spending and investing enough. So, we were told, government must step in and make up the difference with deficit spending to get “idle resources” — like capital goods and labor — back to work.
But what should the government be spending on? Apparently, anything.
This is not an exaggeration. For example, noted Cal-Berkeley economist Brad DeLong insisted in 2009 “At this point, anything that boosts the government’s deficit over the next two years passes the benefit-cost test — anything at all.”
Such thinking reveals one of fatal flaws of mainstream economics: the idea that all the economy is one big homogeneous blob. As Friedrich Hayek put it, “Mr. Keynes’ aggregates conceal the most fundamental mechanisms of change.”
The Problem of Malinvestment
During the 2002-2007 housing boom, significant amounts of capital and labor were organized in very specific locations, combinations and uses at multiple stages of production to produce more houses to satisfy consumer demands. This meant more construction workers employed building homes in growing communities, and more mortgage brokers and investment bankers to finance the boom. It also meant more inputs such as wood, nails, concrete and glass directed toward homebuilding; which in turn required more lumber processing, steel production, and so on.
When the housing bubble burst, millions of these workers became unemployed, and significant portions of the structures of production that were expanded to support the bubble became idle as well. The bursting of the bubble then sent a ripple effect permeating through other sectors of the economy, creating yet more unemployed resources.
For the economy to recover, a major reallocation of these idle workers and resources needed to occur. Idle workers and capital goods needed to be reshuffled to those entrepreneurs ready and willing to employ them in an attempt to meet changing consumer demands.
But this process is not short nor easy. The unemployed workers have specific skills and experience, and many may need training to acquire new skills to meet the changing labor market. Some may be unwilling to move to take new opportunities. How is a laid off bricklayer supposed to find work in a market demanding graphic designers and coders?
The capital goods no longer being utilized likewise have specific uses, and often need specific complementary goods to fulfill their role in the production process. Some of them may end up being liquidated because no entrepreneurs have a need for them. There simply may be too many bulldozers and cement mixers needed given the now smaller, post-bubble construction industry.
Recession: A Process of Re-allocating Malinvested Resources
This process of reshuffling explains the strength and duration of the recession.
Keynesian-inspired economists and politicians, unfortunately, view the idle capital and labor only in the aggregate. Their grand “stimulus” plans involve nothing more nuanced than coaxing consumer spending and business investment into spending more money on anything, anytime, anywhere.
As economic historian Robert Higgs described , “If someone, whatever his skills, preferences, or location, is unemployed, then, in this framework of thought, we may expect to put him back to work by increasing aggregate demand, regardless of what we happen to spend the money for, whether it be cosmetics or computers.”
Simply force-feeding new money into the economy will be ineffective because it takes no account of the true reason why the resources are idle in the first place.
The billions of dollars worth of public works projects, for instance, will mostly draw from labor and capital actively engaged in the private sector and fail to employ idle resources. Say, for instance, Chicago receives millions to build a new road. Can anyone honestly say for certain that the road construction will only employ workers and other inputs sitting idle in the Chicago area due to the housing bust?
Unemployed bankers and carpenters won’t be of much help laying pavement. Rather, the road project will undoubtedly divert labor and machinery actively engaged in private sector projects in the region. In the end, fewer resources will be available for productive, private sector use because they are tied up in government stimulus projects.
Meanwhile, the majority of idle workers and equipment will continue to sit idle.
Moreover, billions of available funds in the capital investment markets will be tied up by government projects; further drying up private investment opportunities.
Government stimulus spending may also artificially inflate the prices of resources, pricing them out of reach for entrepreneurs needing low-priced inputs to attract their investment during uncertain recessionary conditions. The very resources needed to generate recovery will be unavailable, having been diverted to government projects.
The best policy is for government to get out of the way and allow the reallocation of resources to occur unhampered. Government spending can only distort and prolong this process, most likely producing harmful inflationary pressure on prices along the way.
Will next time be any different?
