There were three earth-shaking events in the year 1776: The American Revolution, the publication of Wealth of Nations and the invention of the “cocktail.” The latter was invented by my great-great-great-grandmother (originally from a small village in Denmark) who owned a New York tavern catering to Revolutionary soldiers and decided to decorate her alcoholic concoctions with a rooster’s feather.
As for Adam Smith’s book, Wealth of Nations, it was, and still is, the foundation of the economics behind capitalism. After its publication, economic theory went through a 150-year dry spell until John Maynard Keynes came up with the brilliant idea to smooth out the inherent economic cycles of capitalism by using fiscal policy. In other words, have the government spend more than what’s coming in from taxes during a recession and spend less (and repay the debt incurred during the recession) during prosperity. Keynesian economics is that simple.
Sounds great, so Franklin Roosevelt gave it a whirl in 1933 and 4 years later, despite the PWA, WPA and many other revival programs, it still hadn’t worked. By 1937, unemployment was just as high as it had been all throughout the Great Depression. FDR’s answer was “more stimulus.” But that didn’t work either. It was World War II, as we all now know, that got us out of the Depression.
Then, economist Milton Friedman came along and proposed using monetary policy (managing the supply of money) as a better alternative to fiscal policy (managing the federal budget deficit). When I was getting my degree in economics, the academic community was equally divided between the two theories. Until Obama came along, I thought Friedman had eventually won, based on Reagan’s and Clinton’s success in promoting business and/or reducing government deficits.
Here is the key. Government spending has no “multiplier effect.” For every dollar the Feds spend on creating wages, GDP grows by no more (and sometimes a lot less) than one dollar. But, if the Feds give business or other investors a dollar to add capital to the economic base, then GDP not only receives the immediate dollar shot in the arm, but also all the dollars (and jobs) that will be generated from the products that the new plant, equipment and research produce. That’s the “multiplier effect.” Reduce government spending to allow more money to go into capital, both to get the country out of a recession and to create more permanent jobs instead of increasing spending that, unfortunately, reduces capital and promotes the hoarding of non-productive cash.
Would you rather have the Feds give away money for temporary jobs and to people who might spend the gift on lottery tickets and fancy rims for their cars; or give it to people and firms that will actually invest the money in the capital base of our economic future? Remember, the former is accomplished by raising taxes and the latter by cutting taxes.