All Commentary
Monday, July 1, 1991

Keynesian Budgets Threaten Recovery

The 1991 and 1992 Federal budgets alarm and dismay many economists. They are the very models of Keynesian budgets, calling for a sharp rise in Federal spending as an antidote for recession, They propose to boost Federal spending from $1.25 trillion in fiscal 1990 to $1.45 trillion in 1992, or 15 percent. If we add the expenditures of Desert Storm, which is merely listed as an $8 billion “placeholder” item for supplemental budget requests later in the year, total 1992 spending may exceed $1.5 trillion. As political budgets usually understate the spending totals, actual expenditures may approach $1.6 trillion.

Government expenditures of such magnitude are simply too big to be ignored or taken lightly. They are felt not only throughout the American economy but also all over the globe. After all, they may affect the value of the U.S. dollar which is the standard money Of the world, used widely by governments, Corporations, and individuals. U.S. government spending has pocketbook effects on all continents.

Federal legislators and administrators apparently cannot free themselves from the spell of Keynesianism. It has such a compelling attraction because it elevates to good economics the thing they like to do most—spend other people’s money. Keynesianism permits administrators to yield to any and all spending pressures by Congress, and encourages them to take the lead in new spending initiatives. It confers respectability on political profligacy.

Unfortunately, government spending does not sustain, stimulate, or invigorate an economy. On the contrary, it diverts economic resources to many unproductive uses and thereby aggravates a recession. Boosts in spending allocate more resources to the ever-growing bureaucracy and the favorite recipients of Federal largess. This is why the Federal budgets may actually deepen and prolong the present recession.

The budgets propose higher expenditures on preschool education and preparation of low-income Americans for higher education. They seek more funds toward the reduction of illness and death from preventable diseases. They recommend a sizeable increase of Federal spending for research and development, with special emphasis on basic research, high performance computing, and energy research and development. They argue for more Federal spending on highways and bridges, on airports, the air traffic control system, and the exploration and use of space. They propose to spend more for the expansion and improvement of national parks, forests, wildlife refuges, and other public lands. They call for further increases in Federal spending on drug prevention, treatment, and law enforcement. They would substantially raise Federal outlays to help the Federal Bureau of Investigation fight crime, Federal prosecutors prosecute criminals, and the Federal prison system accommodate more convicts.

To finance the additional spending of $194 billion, the budgets envision $133.7 billion in new tax receipts, user fees, and other collections; the $60.3 billion shortfall is added to the deficits estimated at $318.1 billion in 1991 and $280.9 billion in 1992. Altogether, they probably will exceed $600 billion.

The Seen and the Unseen

Yet despite such massive consumption of economic resources, nowhere do the budget documents reflect on the obvious reduction in economic well-being that Federal taxation and deficit spending inflict on their victims. Nowhere do they mention a $194 billion reduction in individual income that prevents people from spending money for preschool education and preparation for higher education, for the fight against illness and death from preventable diseases, for research and development, for drug prevention and treatment, and so on. Government spending always is presented as a benefit without cost, a grand addition to the general welfare, a social achievement of the highest order.

This popular view of government spending not only springs from the old predilection of politicians for spending other people’s money but also draws support from man’s natural inclination to prefer the seen over the unseen. Government largess is visible to all in the form of various benefits, lucrative contracts and privileges, and public buildings, many of which look like Greek temples built to the gods. What is not seen are the costs borne by millions of people who were forced to do without preschool and higher education, who no longer can afford medical services or purchase health and life insurance, who must forgo better housing and warmer clothing. The marble temples of politics which may last a thousand years are durable monuments to the supremacy of political power over individual freedom and economic prosperity. To a thoughtful person, they speak of onerous taxation and painful extractions that greatly aggravate the plight of the poor.

The Keynesian call for a sharp rise in Federal spending as an antidote for recession is neither thoughtful nor helpful; it completely misinterprets the causes and consequences of recession and, therefore, prescribes the wrong medicine. A recession is a time of readjustment and recovery when businessmen correct the mistakes made in the pastand put their houses back in order. It is an integral part of a business cycle that begins with a boom, leads to a bust, and ends with recovery. If, for any reason, government prevents the readjustment or even promotes more maladjustment, it makes matters worse. In the end, the recession may turn into a deep depression, just like the Great Depression during the 1930s.

The present recession had its beginning during the 1980s when the Federal Reserve System, the monetary arm of the government, ignited a boom with numerous bursts of new money and credit. It helped finance Federal budget deficits of nearly $2 trillion, permitting the Federal debt to rise to $3 trillion, plus approximately $1 trillion in agency debt and off-budget guarantees. It rushed to the rescue of many governments of Third World and former Communist countries which incurred and now labor under $600 billion of foreign debt. The Fed kept alive hundreds of banks and S&Ls suffering in the vise of regulation and inflation. Helping to build large pyramids of junk-bond debt, it facilitated a great takeover game that enabled promoters and speculators to assume control over giant corporations. Banks amassed $700 billion in loans for mergers and acquisitions and another $700 billion in loans on real estate. The Fed even financed the rescue of various corporations and city governments chafing under heavy loads of political debt.

During the 1980s total debt nearly doubled to an estimated $12 trillion, much of which is of low quality. The growth of debt did not lead to economic growth; instead, it facilitated government handouts and corporate mergers, acquisitions, and leveraged buy-outs. It caused real estate and stock prices to rise dramatically, while economic output, according to the Tax Foundation, stagnated, and median average income after direct Federal taxation and inflation declined by 9.2 percent.

Recovering from Recession

A recession or depression is a cleansing affair that exposes mistakes and manipulations and calls for corrections and remedies. The present recession is the inevitable consequence of the mountains of unproductive debt that financed many ill-advised ventures and now weighs heavily on the debtors. It will end as soon as the debt burden has been reduced to a more bearable level. Debt relief may come through bankruptcy and rescheduling, write-offs, and pay-offs. The end may be in sight when falling interest rates signal not only a decline in lending risk, but also the arrival of new savings in the market.

Under the sway of Keynesian thought, many politicians and officials are determined to hasten recovery through deficit spending and money creation, which they call “contra-cyclical.” Actually, their policies are “contra-recovery”; they aggravate and prolong the recession by consuming capital en masse, crowding out business, and depressing business activity. The currency and credit expansion falsely lowers interest rates, which again misleads businessmen in their investment decisions. In short, government deficit spending and money manipulation are the most potent recovery suppressors.

The present recession may prove this point. When Federal deficits are made to swell to Unprecedented levels while the recession deepens and lingers on, the Keynesian model obviously fails to demonstrate economic reality. It misinterprets the causes of recession and, therefore, prescribes a wrong medicine, in fact, a very harmful medicine.

There are three types of people in the world. Some learn from their own mistakes—they are experienced and wise. Others learn from deliberation and observation of the experience of others—they are diligent and intelligent. The third type learns neither from their own experience nor the experience of others—it comprises the fools. The severity and length of the present recession will clearly reveal which type of legislator and administrator is holding forth in Washington.

  • Hans F. Sennholz (1922-2007) was Ludwig von Mises' first PhD student in the United States. He taught economics at Grove City College, 1956–1992, having been hired as department chair upon arrival. After he retired, he became president of the Foundation for Economic Education, 1992–1997.