This article was originally published by Frank Shostak at The Mises Institute.
Some commentators are of the view that one cannot trust the market economy, which is seen as inherently unstable. If left free, the market economy could lead to self-destruction. Hence, there is a need for the government and the central bank to manage the economy. It is held, in this framework, that successful management could be achieved by influencing overall expenditure; it is expenditure that generates income. An expenditure by one individual becomes the income of another individual.
Hence, the more that is spent, the higher the overall income will be in the economy. What drives the economy, then, is spending. Whenever the overall income in the economy starts to weaken because consumers lower their expenditure, it is then the role of the government to step in and increase its expenditure, thereby generating support for the overall income and thus for overall economic growth.
If, for whatever reasons, demand for produced goods is not strong enough, this results in a partial use of the existing labor and capital goods. Thus, in this framework, it makes a lot of sense to increase the government expenditure in order to strengthen the overall demand, thereby raising the use of labor and capital.
Contrary to popular thinking, the key to economic growth is not an increase in demand but an increase in production and saving. It is not possible to strengthen the overall production without the support of savings. For instance, through saving and capital investment, an individual or economy is able to increase production, and—only after that—consumption. Saving and capital investment, enabling new and greater production, allow for the attainment of various goals, which—prior to the increase in production—weren’t possible.
The introduction of money doesn’t alter the essence of what is described above. Money is just the medium of exchange. By means of money, something is exchanged for something else. It is employed to facilitate the flow of goods; it cannot replace goods. Paraphrasing Jean Baptiste Say, Mises held that,
Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.
Since the government is not a wealth-generating entity, how can an increase in government outlays revive the economy? Various individuals who are employed by the government expect compensation for their work. The only way it can pay these individuals is by taxing others who are still generating wealth. By doing this the government weakens the wealth-generating process and undermines the prospects for sound economic growth and recovery.
Much popular thinking takes the supply of goods and services for granted; all that is required to boost economic growth is to strengthen the demand for goods and services (i.e., demand creates supply). But the increase in the supply of goods and services requires an improved infrastructure. This, in turn, requires an increase in voluntary, private savings to sustain various individuals that are engaged in the expansion and the enhancement of the structure of production.
If genuine savings are expanding, then there can be economic growth. Furthermore, if the pool of savings is large enough, it could support wealth-generating and non-wealth-generating activities. If, however, the flow of savings is declining, then—regardless of the fiscal and monetary stimulus—overall economic activity will come under pressure. There is not enough savings to support economic growth. Moreover, the more the government spends and the more the central bank inflates, the more will be extracted from wealth-generators, thereby weakening any prospects for genuine economic recovery.
As the pace of expansionary policies intensifies, a situation could emerge whereby capital consumption and deterioration takes place. Consequently, production will decline. Similarly, other wealth-generators, as a result of the increase in government spending and central bank monetary policy, will be left with less savings at their disposal. This will hamper the production of their goods and services and retard, not promote, overall economic growth. Not only does an increase in expansionary fiscal and monetary policies not raise overall output, but, on the contrary, it leads to a weakening in the process of wealth-generation in general.
A Return to Economic Reality
The conventional thinking presents an economic adjustment—also labeled as an “economic recession”— as something terrible that must be prevented and avoided at all costs. In fact, the economic adjustment is not menacing or terrible; from an economic point of view, it is a time when scarce resources are reallocated in accordance with consumers’ priorities.
Allowing the market to do the allocation always leads to better results. Even the founder of the Soviet Union, Vladimir Lenin, understood this when he introduced the market mechanism for a brief period in March 1921 to restore the supply of goods and prevent an economic catastrophe. Yet most experts these days cling to the view that the market cannot be trusted in difficult times.
Contrary to popular thinking, expansionary fiscal and monetary policies do not rescue the economy, but rescue activities that consumers can’t afford and/or don’t want at existing prices. The expansionary policies sustain waste and promote inefficiency. The best economic policy when the economy falls into an economic slump is for the central bank and government to do nothing as soon as possible. By doing nothing, the central bank and the government will enable wealth-generators to accumulate savings. The policy of doing nothing will force various activities that add nothing to saving, capital investment, and production to disappear. As time goes by, expanding savings can set the platform for an expansion of various wealth-generating activities.
Conclusion
Contrary to mainstream economics, neither the central bank’s expansionary monetary policy nor the government’s expansionary fiscal policies can cause an increase in savings or production. On the contrary, the expansionary policies weaken the process of savings formation, thereby weakening the prospects for economic growth.
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