Give the Man a Nobel Prize Already!

There’s always something funny to report from the wacky world of our central planning bien pensants, (a.k.a. “high IQ morons” – h/t Bill Bonner), especially when one of them has a sudden personal epiphany he feels he must immediately impart so that we can go about rescuing the world by implementing his plan and no other.

One of the biggest problems central planners of all stripes face is that even the otherwise lethargic couch potatoes realize deep down that there is no such thing as a free lunch. So what could be better then discovering one? Larry Summers has apparently just succeeded in this task, as he reports in a Financial Times editorial entitled “Why Public Investment Really Is a Free Lunch”.

So which economic laws are going to be magically suspended by this wizardry? Summers indicates in the sub-title of his editorial that he has got it on extremely good authority that public spending is where its at after all: “The IMF finds that a dollar of spending increases output by nearly $3”, we are informed.

Well, if the IMF “finds” so, who are we to disagree? Everybody knows the IMF is full of businessmen speculatively appraising the future for its profit-making possibilities, right? It’s not as if it were just an ivory tower full of academic economists of the Keynesian persuasion who haven’t the foggiest idea about business and are busy constructing “garbage-in, garbage-out” economic models all day long. A few excerpts from Summers’ editorial:

“It has been joked that the letters IMF stand for “it’s mostly fiscal”. The International Monetary Fund has long been a stalwart advocate of austerity as the route out of financial crisis, and every year it chastises dozens of countries for their fiscal indiscipline. Fiscal consolidation – a euphemism for cuts to government spending – is a staple of the fund’s rescue programs. A year ago the IMF was suggesting that the US had a fiscal gap of as much as 10 per cent of gross domestic product.

All of this makes the IMF’s recently published World Economic Outlook a remarkable and important document. In its flagship publication, the IMF advocates substantially increased public infrastructure investment, and not just in the US but much of the world. It asserts that when unemployment is high, as it is in much of the industrialized world, the stimulative impact will be greater if investment is paid for by borrowing, rather than cutting other spending or raising taxes. Most notably, the IMF asserts that properly designed infrastructure investment will reduce rather than increase government debt burdens. Public infrastructure investments can pay for themselves.

Why does the IMF reach these conclusions? Consider a hypothetical investment in a new highway financed entirely with debt. Assume – counter-factually and conservatively – that the process of building the highway provides no stimulative benefit. Further assume that the investment earns only a 6 per cent real return, also a very conservative assumption given widely accepted estimates of the benefits of public investment. Then, annual tax collections adjusted for inflation would increase by 1.5 per cent of the amount invested, since the government claims about 25 cents out of every additional dollar of income.Real interest costs, that is interest costs less inflation, are below 1 per cent in the US and much of the industrialized world over horizons of up to 30 years. So infrastructure investment actually makes it possible to reduce burdens on future generations.”

(emphasis added)

The IMF finally agrees with Larry! Hallelujah! Now, allow us to point out here, that the IMF definitely didn’t agree with him back in 2008. At that time an extensive IMF study “proved” the exact opposite, namely that the long-run fiscal multiplier is 0,80 – more precisely, it found that government spending of $1 creates net economic value of $0,80 over a period of 20 quarters – in short, it effectively destroys wealth (here is a link to the study itself, pdf). This is incidentally far more credible than its recent volte-face.

Summers assumes above that building a new highway will produce a 6% real return. But how does he know? He doesn’t say – we are just supposed to “assume” that any putative new highway will be superior to Keynesian ditch-digging. However, it is simply not possible for the State’s bureaucracy to know what the return on this investment will be, and what opportunity costs its construction involves. This is why grandiose pushes to increase infrastructure spending tend to leave the countries involved with countless bridges to nowhere. Bureaucrats don’t construct or run a highway according to business principles. They are severely hampered in terms of economic calculation, which they can only apply in the most rudimentary manner by observing outside markets. However, since there are practically no privately-owned roads, there is no outside market that can be observed in this case – in other words, the “real return” of a new highway will remain a complete mystery to them. It is far more likely to simply end up as an example of capital consumption than ever producing this mythical return.

As we have pointed out previously, the economy is as a rule much safer when this man is fast asleep.

(Photo credit: Chip Somodevilla / Getty Images)

Capital is Scarce

We concede of course that a highway has its uses. But there are already countless highways. How will Larry, or indeed the bureaucrats ultimately making the decision, know if another one is needed? If they build one, it will require that factors of production (capital, land and labor) be withdrawn from alternative uses where they were previously employed.

It cannot be smugly assumed that the government will only requisition so-called “idle resources”. As an aside to this, idle resources are either the left-overs of the malinvestments of the previous boom – in which case their existence simply indicates that their owners have not yet been prepared to drop their prices sufficiently to sell them – or they have indeed an economic function. For instance, a factory may have a number of idle machines standing around so as to be able to react to unexpected short term surges in demand.

Larry’s proposal is full of assumptions, none of which can really be tested. If we are assuming the new highway will produce a real return of X, then we may assume that tax collections will increase by Y, which we can compare to interest expenses Z, once again assuming that interest rates don’t become unruly and remain where they currently are forever and ever.

Moreover, he commits the sin of not really considering opportunity costs or the scarcity of capital. Every penny the State spends is a penny the private sector can no longer invest or spend. The government does not possess a secret stash of resources or a reserve army of laborers that can be deployed in horn-of-plenty fashion. It is an apodictic certainty that when the government spends money on whatever projects it decides to undertake, some other enterprise can no longer be undertaken. While we don’t know what that other undertaking is, it is highly likely that it would satisfy more urgent consumer wants. Businessmen active in the marketplace can at least gauge such consumer wants and the best possible deployment of scarce capital by means of economic calculation – the very thing that is practically a closed book to the bureaucrats, whose pursuits are not guided by the profit motive. Also, people react to an increase in government spending: they know that they will eventually face higher taxes and/or more inflation to pay for it. They will accordingly become far less eager to take risks and will curtail their own spending and investment plans accordingly.

In a very limited way, the bureaucracy is of course able to maintain and expand needed infrastructure the upkeep and construction of which has been reserved to it by looking at certain data. For instance, it may be found that traffic congestion has increased in certain areas. Then it may make sense to build a new road, or add a lane to an existing road. Or engineers may find upon controlling a bridge that certain parts of it must be renewed to ensure its continued safety. The less centralized this bureaucratic system of infrastructure upkeep is, the more efficient it will be. In other words, infrastructure is largely a local issue.

However, the fact that certain infrastructure items have become “wards of the State” instead of being open to the private sector (such as roads), has a regressive effect on economic development. Not only are scarce resources as a rule wasted on a grand scale and political cronies rewarded, but no-one in the private sector any longer has a motive to look for alternatives to the basic problem roads are supposed to address, namely transportation.

Whenever someone asks “who would build the roads if there were no government”, they are in fact asking the wrong question. Leaving aside the fact that if roads were run as businesses, they would be both cheaper and in better repair, the question is really: where are our personal flying machines? Why don’t we have teleportation devices already? There is nothing special about roads – they are a means of getting from A to B more comfortably and faster. However, by making them a State monopoly, we are foregoing all the ingenious solutions to transportation the market could and would provide. We don’t know what they would look like, preciselybecause the private sector has been excluded.

Lastly, one of the reasons why Summers believes he is on safe ground by arguing for more debt-financed spending on infrastructure is that lobbyists are perennially pushing the myth of America’s “crumbling infrastructure” (they are recently doing the same in Europe by the way). David Stockman has expertly eviscerated this myth here by discussing America’s bridges, which according to politicians and lobbyists have been “dangerously crumbling” since at least 1982 (it is a miracle any of them are still standing!). There is onlyone reason why this notion has been so persistently forwarded that it has become a widely accepted “home truth” – there are special interest groups that will benefit greatly from the associated spending. As so often, one can find the truth by simply “following the money”.

No, America’s infrastructure is not “crumbling”.

(Photo via redtrail.co.uk, author unknown)

Conclusion:

In reality, Summers is just crying for more Keynesian deficit spending, as he has done for many years already. There is no proof whatsoever that any of this spending will “pay for itself” as Summers avers. If government spending were profitable, there would actually be profits to report from time to time. It seems obvious that this is not the case and indeed it cannot be the case, due to the fact that bureaucracies cannot engage in proper economic calculation.

Summers believes this debtberg  – via Saint Louis Federal Reserve Research – should be expanded even faster – click to enlarge (chart, not debtberg).

As Keynesians are wont to do, Summers blithely ignores the unseen effects of such large scale government intervention in the economy. It is a very good bet that if governments were to heed his advice, the end result would be the erection of countless “bridges to nowhere”, both in the proverbial and literal sense. Political cronies and well-connected special interests would all get to skim off a lot of money, and future generations would find out to their great chagrin that all these grandiose investments actually did not “pay for themselves”.

The Keynesian models allegedly proving this are as a rule based on Keynesian premises from the outset: theyassume as a given that government spending will produce positive outcomes, and are constructed in a manner that ensures a priori that only positive results are obtained. They are a prime example of “garbage in, garbage out”.

If increased government spending really were promising to be a “free lunch” as Summers avers, government should of course be spending with both hands all the time. Unfortunately, the economic free lunch is just as real as the perpetuum mobile. It simply doesn’t exist outside of Larry Summers’ overactive imagination.