By Dr Frank Shostak
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 the need for the government and the central bank to manage the economy. It is held in this framework of thinking, that successful management could be achieved by influencing overall expenditure. In this way of thinking 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 display weakening because consumers lower their expenditure, it is then the role of the government to step in and increase its expenditure, thereby generating support to the overall income and thus to overall economic growth, so it is held.
By this way of thinking for a given technology the greater the pool of resources i.e. labour, tools and machinery the more output can be generated. If for whatever reasons the demand for the produced goods is not strong enough, this results in a partial use of the existent labour and capital goods.
In this framework then, it makes a lot of sense to increase the government expenditure in order to strengthen the overall demand thereby raising the use of labour and capital.
Contrary to popular thinking, the key for economic growth is not an increase in demand but an increase in savings. Note that it is not possible to strengthen the overall production without the support from savings. For instance, by means of a saved consumer good – the bread – the baker is able to fund the expansion of his infrastructure. With better infrastructure the baker could increase the production of bread. The increase in the production in turn for a given consumption is going to increase savings. This in turn will enable the baker to increase his production of bread further. Consequently, for a given consumption the increase in production and thus savings will permit the attainment of various goals, which prior to the increase in production weren’t possible. Similarly other producers must have saved consumer goods –savings – to fund the expansion and the enhancement of the infrastructure in order to strengthen the production of goods and services.
Note that the introduction of money doesn’t alter the essence of what funding is. 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 an economic recovery.
The popular thinking takes the supply of goods and services for granted. Note, that by popular thinking all that is required to boost the economic growth rate is to strengthen the demand for goods and services i.e. demand creates supply. Note again that the increase in the supply of goods and services requires an improved infrastructure. This in turn requires an increase in the pool of savings to sustain various individuals that are engaged in the expansion and the enhancement of the infrastructure.
Now, if the pool of savings is expanding, then there is going to be economic growth. Furthermore, if the pool of savings is large enough it could support wealth and non-wealth generating activities.
If, however, the flow of savings is declining then regardless of the fiscal and monetary stimulus, overall economic activity would come under pressure. There is not enough savings to support economic growth. Moreover, the more the government spends and the more the central bank pumps, the more will be taken from wealth generators, thereby weakening any prospects for economic recovery.
When expansionary monetary and fiscal policies divert bread from the baker he will have less bread at his disposal. Consequently, the baker will not be able to secure the services of the oven maker whom the baker pays by means of the bread. As a result, it will not be possible to increase the production of bread, all other things being equal.
As the pace of expansionary policies intensifies, a situation could emerge whereby the baker is not going to have enough bread to maintain the workability of the existing oven. (The baker will not have enough bread to pay for the services of a technician to maintain the existing oven in a good shape). Consequently, the baker’s production of bread will decline.
Similarly, other wealth generators, as a result of the increase in government outlays and central bank monetary pumping, will be left with a fewer savings at their disposal. This is going to hamper the production of their goods and services and is going to retard and not promote overall economic growth.
Not only does a strengthening in the expansionary fiscal and monetary policies do not raise the overall output, but on the contrary, it leads to a weakening in the process of wealth generation in general.
How economic cleansing promotes economic growth
The conventional thinking presents an economic adjustment — also labelled as an “economic recession” — as something terrible. In fact, the economic adjustment is not menacing or terrible; from an economic point of view, it is a time when scarce resources are allocated 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. The expansionary policies sustain waste and promote inefficiency. We suggest that 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 the pool of savings to disappear. As time goes by, the expanding pool of savings is going to 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 expansionary fiscal policies can cause an increase in the pool of savings. On the contrary the expansionary policies weaken the process of savings formation thereby weakening the prospects for economic growth.
