The Fallacy of Stimulus Spending

Robert Book / January 23, 2009

Everyone in Washington seems to agree that a huge package of “stimulus spending” will get the economy back on track to prosperity. The problem with stimulus spending is that the government has to get the money from somewhere. Every dollar the government spends has to come from either taxing or borrowing, or deliberately causing inflation.

One might be tempted to conclude that there is a finite supply of wealth, and government can divide up the pie in different ways, but can’t make it any bigger. This is of course not true. The right policies can induce economic growth – but government spending cannot. Economic expansion can be achieved by increasing total production, but not by moving it around. For the economy to expand, entrepreneurial individuals and companies have to find it worthwhile to engage in productive activity and investment.

Rather than producing free, effortless prosperity, “stimulus spending” is to economics what a “perpetual motion machine” is to physics. If you look at one part of the machine and ignore the rest, it can look like it’s giving you something for nothing. But when you look at the whole picture, it’s actually wasting energy, leaving you worse off than before, due to friction or some other source of thermodynamic inefficiency.

If they tax to get the money, the dollar they spend is a dollar some taxpayer couldn’t spend (since she had to pay the taxes), so the increase in government spending is cancelled out by a decrease in private spending. So, there’s no actual “stimulus.”

If they borrow to get they money, the dollar they spend is a dollar that wasn’t available for someone else to borrow (to buy a car, build a factory, whatever). So, the increase in government spending is cancelled out by a decrease in private spending. So, there’s no actual “stimulus.” (more…)