The Excuse for the Government to Spend and to Run a Perpetual Deficit Has Taken on Different Forms: “Prime the Pump,” “Theory of Secular Stagnation,” and the “Balance Wheel Theory”

Ever since the New Deal, a primary excuse for the expansion of governmental activity at the federal level has been the supposed necessity for government spending to eliminate unemployment. The excuse has gone through several stages. At first, government spending was needed to “prime the pump.” Temporary expenditures would set the economy going and the government could then step out of the picture.

When the initial expenditures failed to eliminate unemployment and were followed by a sharp economic contraction in 1937-38, the theory of “secular stagnation” developed to justify a permanently high level of government spending. The economy had become mature, it was argued. Opportunities for investment had been largely exploited and no substantial new opportunities were likely to arise. Yet individuals would still want to save. Hence, it was essential for government to spend and run a perpetual deficit. The securities issued to finance the deficit would provide individuals with a way to accumulate savings while the government expenditures provided employment. This view has been thoroughly discredited by theoretical analysis and even more by actual experience, including the emergence of wholly new lines for private investment not dreamed of by the secular stagnationists. Yet it has left its heritage. The idea may be accepted by none, but the government programs undertaken in its name, like some of those intended to prime the pump, are still with us and indeed account for ever-growing government expenditures.

More recently, the emphasis has been on government expenditures neither to prime the pump nor to hold in check the specter of secular stagnation but as a balance wheel. When private expenditures decline for any reason, it is said, governmental expenditures should rise to keep total expenditures stable; conversely, when private expenditures rise, governmental expenditures should decline. Unfortunately, the balance wheel is unbalanced. Each recession, however minor, sends a shudder through politically sensitive legislators and administrators with their ever present fear that perhaps it is the harbinger of another 1929-33. They hasten to enact federal spending programs of one kind or another. Many of the programs do not in fact come into effect until after the recession has passed. Hence, insofar as they do affect total expenditures, on which I shall have more to say later, they tend to exacerbate the succeeding expansion rather than to mitigate the recession. The haste with which spending programs are approved is not matched by an equal haste to repeal them or to eliminate others when the recession is passed and expansion is under way. On the contrary, it is then argued that a “healthy” expansion must not be “jeopardized” by cuts in governmental expenditures.

--Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1982), 75-76.

There Is As Much Sense in Saying That Capital Exploits Labor As in Saying That Labor Exploits Capital, or That Electricity Exploits Roofing Tiles

One of the many fateful consequences of marginal productivity is that it sweeps away such theories as Marx's which see interest as consisting of 'unpaid labor.' Under competitive market conditions, a worker tends to be paid what his labor contributes to output, no more and no less. The same goes for the owner of a machine or a piece of real estate. The analysis demonstrates the symmetry of all types of inputs: there is as much sense in saying that capital exploits labor as in saying that labor exploits capital, or that electricity exploits roof tiles. Of course, this does not touch the ethical arguments of socialists who acknowledge that non-labor factors make a determinate contribution to output, analytically separable from labor's contribution, yet still contend that it is illegitimate for anyone to own capital or land and reap the payment for their services. But that is not the position of Marx, nor of many other socialists. They specifically contend that, given a resource-owner's right to the product of the resource he contributes to production, positive net incomes to non-labor resource-owners are entirely created by owners of labor resources. It certainly clarifies the discussion to recognize that this position is untenable.

--David Ramsay Steele, From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation (La Salle, IL: Open Court Publishing, 1992), Kobo e-book.

"Democratic National Planning" Stemmed from a Faith in Expert Knowledge based on Social Scientific Research; Planners Retained a Disproportionate Faith in Presidential Power

Congressional critics were striking out at a false god--regimented, totalitarian state planning. No such beast existed in America. The planners' notion of advisory national planning did not contain the rigidities of fascist, Nazi, or Soviet command-style economic planning dominated by the state. Their idea of "democratic national planning" stemmed from an inordinate faith in the utility of expert knowledge based on social scientific research by participants in the organizational nexus built since the 1920s. The planners retained a disproportionate, at times almost irrational, faith in presidential power as exercised by Franklin D. Roosevelt. Liberal Democrats in the postwar period carried this faith in the presidency, little realizing the implicit dangers of what eventually came to be called the imperial presidency.

--Patrick D. Reagan, Designing a New America: The Origins of New Deal Planning, 1890-1943, Political Development of the American Nation: Studies in Politics and History (Amherst, MA: University of Massachusetts Press, 1999), e-book, 232.

Corporate Income Tax Is a Hidden Tax That the Public Pays in the Prices It Pays for Goods and Services; Personal Tax Rates Are Highly Graduated on Paper but It's Pure Window Dressing

The personal income tax is sadly in need of reform. It professes to adjust the tax to "ability to pay," to tax the rich more heavily and the poor less heavily and to allow for each individual's special circumstances. It does no such thing. Tax rates are highly graduated on paper, rising from 14 to 70 percent. But the law is riddled with so many loopholes, so many special privileges, that the high rates are almost pure window dressing. A low flat rate--less than 20 percent--on all income above personal exemptions with no deductions except for strict occupational expenses would yield more revenue than the present unwieldy structure. Taxpayers would be better off--because they would be spared the costs of sheltering income from taxes; the economy would be better off--because tax considerations would play a smaller role in the allocation of resources. The only losers would be lawyers, accountants, civil servants, and legislators--who would have to turn to more productive activities than filling in tax forms, devising tax loopholes, and trying to close them.

The corporate income tax, too, is highly defective. It is a hidden tax that the public pays in the prices it pays for goods and services without realizing it. It constitutes double taxation of corporate income--once to the corporation, once to the stockholder when the income is distributed. It penalizes capital investment and thereby hinders growth in productivity. It should be abolished.

--Milton Friedman and Rose Friedman, Free to Choose: A Personal Statement (San Diego: Harcourt Brace and Company, 1990), 306.

The Three Dimensions of Capital and Capital Structure: A Value Dimension, a Time Dimension, and the Jevons-Cassel Composite Dimension Called “Aggregate Production Time”

One of the most distinctive features of Austrian macroeconomic theory is its use of the concept of a "structure of production." This concept was formulated to give explicit recognition to the notion that capital (and the capital structure) has two dimensions. It has a value dimension which can be expressed in monetary terms, and it has a time dimension which is an expression of the time that elapses between the application of the "original means of production" (labor and land) and the eventual emergence of the consumption goods associated with them. The development of the notion of two-dimensional capital has its roots, of course, in the writings of Jevons. It can be traced from Jevons to Cassel and Böhm-Bawerk and then to Mises, and from Mises to Hayek, Rothbard, and other contemporary Austrian theorists. This view of capital, then, is neither new nor is it strictly Austrian, yet the notion of two-dimensional capital is by no means readily accepted by capital theorists in general.

A third though not independent dimension of capital can be envisaged which represents a composite of the two dimensions described above. Again, Jevons was the first to synthesize this third dimension. He made the distinction between the "quantity of capital" and the "length of time during which it remains invested." He then devised the third dimension of capital by" ... multiplying each portion of capital invested at any moment by the length of time for which it remains invested." The compounding of interest was ignored for the sake of simplicity. The resulting composite dimension was shown to have the units of "dollar-years." (The units are Americanized here. Jevons, of course, used "pound-years.")

Cassel followed thirty years later with a similar formulation: " . . . interest is paid in proportion to the capital lent and in proportion to the duration of the loan, i.e., in proportion to the product of value and time" (emphasis added). Cassel's product and Jevons's composite dimension measure the same thing. They are indications of the extent to which capital is "tied-up" in the production process. No claim is made here that this product can be calculated directly, but if we can conceive of interest income and of the rate of interest, then we can conceive of this composite dimension of capital--the amount of "waiting" or postponement of consumption brought about by the payment of interest.

This composite dimension will be referred to as "aggregate production time" or simply as "production time." For sure, there are problems in aggregating (even conceptually) the production time associated with different pieces of capital just as there are problems with all macroeconomic aggregates. Much ambiguity will be avoided, however, by using the concept of aggregate production time rather than average production time or average period of production.

--Roger W. Garrison, Austrian Macroeconomics: A Diagrammatical Exposition, Studies in Economics 5 (Menlo Park, CA: Institute for Humane Studies, 1978), 5-6.

The First New Deal Was a Scheme to turn the U.S. Economy into One Massive, Government-Run System of Cartels; the NIRA Was an Economy-Wide Minimum Wage and Maximum Hour Program

In The Roosevelt Myth, John T. Flynn devotes his sixth chapter to "The Dance of the Crackpots," which describes many of the quite literally crackpot ideas that were widely discussed in Washington during the early 1930s. Unfortunately, FDR adopted one of these crackpot ideas as the primary basis of his economic policy. The central idea was based on an interpretation of the Depression that had cause and effect exactly backward. The main cause of the Depression, FDR and his advisers believed, was low prices. The Depression did not cause low prices and wages, then contended; low prices and wages caused the Depression. Therefore, the "obvious solution" to the Depression was government-mandated price and wage increases (to ostensibly increase "purchasing power"), which is what the National Industrial Recovery Act (NIRA) and the Agricultural Adjustment Act attempted to do. The former act sought to cartelize virtually every industry in America under the auspices of the federal government (while suspending the antitrust laws); the latter act sought to do the same for agriculture.

The First New Deal was essentially a scheme to turn the U.S. economy into one massive, government-run system of industrial and agricultural cartels. At a time when underemployment or unemployment of resources, including labor resources, was of tragic proportions, the focus of the government was to restrict output and employment even further with supply-reducing cartel schemes and limitations on hours worked.

The scheme was always destined to fail, of course, because of several major confusions. First, if wages are forced up by government fiat, the effect is to reduce the demand for labor, which creates more unemployment.

It is well-known that the minimum wage law causes unemployment, especially among lower-skilled workers. But at least the minimum wage law primarily applies only to entry-level employees and is therefore limited in the amount of harm it can do. The NIRA was an economy-wide minimum wage (and maximum hour) program that rendered the job-destroying effect of the minimum wage law universal.

Second, higher prices caused by a government-run cartel scheme may increase the incomes of some sellers, but only by reducing the incomes of buyers by an equivalent amount. On net, the economy is not "stimulated." The NIRA was the public policy equivalent of a Rube Goldberg machine.

--Thomas J. DiLorenzo, "Franklin Delano Roosevelt's New Deal: From Economic Fascism to Pork-Barrel Politics," in Reassessing the Presidency: The Rise of the Executive State and the Decline of Freedom, ed. John V. Denson (Auburn, AL: Ludwig von Mises Institute, 2001), 430-431.

The Distortions Created by Central Banks Go Beyond Those Considered by the Traditional ABC Theory; Financial Bubbles and Crashes Can Be Linked to the Action of Central Banks

The Austrian School of Economics has historically put its focus on the relationship between monetary expansions, not backed by a voluntary increase of savings, and the productive structure. Thus, the ABCT [Austrian Business Cycle Theory] has analyzed how monetary expansions distort the allocation of resources between consumer and capital goods, generating periods of boom and busts (Mises [1912] 1981, Hayek 2008 and Huerta de Soto 2009). However, little attention has been paid to the distortions created by monetary expansions on the financial structure of the economy.

In this paper, I will try to describe the different links between monetary expansions and the financial structure of an economy, argue that the financial effects of monetary expansions play a significant role in the development of business cycles, and explain why the distortions created by central banks go beyond those taken into account by the traditional ABCT. Specifically, I will discuss how financial bubbles and crashes can be linked to the action of central banks, through the impact of monetary expansions in the agents’ balance sheets, which generate an excessively fragile financial structure that is, at the same time, reliant on an unsustainable productive structure.

--Rafael García Iborra, "Financial Effects of Monetary Expansions," Procesos de Mercado: Revista Europea de Economía Política 15, no. 1 (Spring 2018): 76.

Say’s Law Applied to a Monetary Economy of n Goods, x1, x2, x3 ,…, xn-1, M, Where M Is the Money Good; Of Course, This Is Precisely the Way Free Markets Work

The principle that has come to be known as Say’s law is considered to be an essential element of classical economics. Properly understood, there are two aspects to Say’s law: 1) there can never be a glut of goods in general; 2) there can be a glut of some goods matched by an insufficiency of other goods. Say himself understood this principle to apply to monetary as well as barter economies. It is the case of monetary economies that is relevant for the purposes of this paper.

Say’s Law applied to a monetary economy of n goods,  x₁,…, x_n-1, M, where M is the money good. Say (1880) maintains that there can never be a glut of the n goods combined; however, there can be a surplus of any subset of the n goods, in which case there necessarily would be a paucity of the goods in the complementary subset. More simply put, there cannot be too many goods in general, but there can be too many of some goods and not enough of others (Sowell, 1972). In such cases, there is a misallocation of resources. Producers have misjudged consumers’ sentiments and produced a suboptimal mix of goods. What is required is a realignment of relative prices such that prices of those goods in excess be decreased relative to the prices of those of which there is a dearth. Of course, that is precisely the way free markets work. The producers of the «glut goods» make actual losses and the producers of «dearth goods» forego potential profits. Their response is to adjust prices altering the structure of prices and reallocating resources more in accord with the desires of consumers. And, it makes no difference if M is the sole good for which there is an insufficiency.

--William Barnett II and Walter Block, "On Say's Law, Keynes's Money, and Post Keynesians," Procesos de Mercado: Revista Europea de Economía Política 4, no. 2 (Autumn 2007): 140-141.

Time and Again, Utopian Attempts to Form Institutions or Societies Exempt from the Iron Law of Oligarchy Have Fallen Prey to That Law; Instead We Should “Circulate” the Elites

One of the most important sociological laws is the “Iron Law of Oligarchy”: every field of human endeavor, every kind of organization, will always be led by a relatively small elite. This condition will hold sway everywhere, whether it be a business firm, a trade union, a government, a charitable organization, or a chess club. In every area, the persons most interested and able, those most adaptable to or suited for the activity, will constitute the leading elite. Time and again, utopian attempts to form institutions or societies exempt from the Iron Law have fallen prey to that law: whether it be utopian communities, the kibbutz in Israel, “participatory democracy” during the New Left era of the late 1960s, or the vast “laboratory experiment” (as it used to be called) that constituted the Soviet Union. What we should try to achieve is not the absurd and anti-natural goal of eradicating such elites, but, in Pareto’s term, for the elites to “circulate.” Do these elites circulate or do they become entrenched?

The free market economy provides an unparalleled example of a continuing healthy circulation of elites. In this dynamic economy, failure to keep up with competitors, failure to satisfy the demands of consumers in the best possible way, will topple elites quickly and establish new ones who do the job better. Ludwig von Mises wrote frequently of the inappropriateness of leftists referring to so-and-so as the “Steel King” or the “Automobile King”; for consumers frequently uncrown these alleged monarchs. Dethroning of financial monarchs on Wall Street is a frequent phenomenon. There are innumerable striking examples of big businesses failing to grasp the importance of a new product or new development, and of losing out to newer upstarts. I will refer to only two glaring cases experienced in my lifetime: the cry of leftists to “break up A&P” in the 1930s because of its alleged “monopoly” of the retail grocery business; and the failure of the old-time photography “monopolist” Eastman-Kodak to grasp the enormous significance, after World War II, of either instant photography or xerography, thereby leaving the field to newer, and more alert competitors.

--Murray N. Rothbard, "Bureaucracy and the Civil Service in the United States," Journal of Libertarian Studies 11, no. 2 (Summer 1995): 4.

Opponents of the Market Economy Have Shifted Their Ground; They Now Oppose It on "Social" rather than Economic Grounds; They Accuse It of Being Unjust rather than Inefficient

Everywhere today in the free world we find the opponents of the market economy at a loss for plausible arguments. Of late the "case for central planning" has shed much of its erstwhile luster. We have had too much experience of it. The facts of the last forty years are too eloquent.

Who can now doubt that, as Professor Mises pointed out thirty years ago, every intervention by a political authority entails a further intervention to prevent the inevitable economic repercussions of the first step from taking place? Who will deny that a command economy requires an atmosphere of inflation to operate at all, and who today does not know the baneful effects of "controlled inflation?" Even though some economists have now invented the eulogistic term "secular inflation" in order to describe the permanent inflation we all know so well, it is unlikely that anyone is deceived. It did not really require the recent German example to demonstrate to us that a market economy will create order out of "administratively controlled" chaos even in the most unfavorable circumstances. A form of economic organization based on voluntary cooperation and the universal exchange of knowledge is necessarily superior to any hierarchical structure, even if in the latter a rational test for the qualifications of those who give the word of command could exist. Those who are able to learn from reason and experience knew it before, and those who are not are unlikely to learn it even now.

Confronted with this situation the opponents of the market economy have shifted their ground; they now oppose it on "social" rather than economic grounds. They accuse it of being unjust rather than inefficient. They now dwell on the "distorting effects" of the ownership of wealth and contend that "the plebiscite of the market is swayed by plural voting." They show that the distribution of wealth affects production and income distribution since the owners of wealth not merely receive an "unfair share" of the social income, but will also influence the composition of the social product: Luxuries are too many and necessities too few. Moreover, since these owners do most of the saving they also determine the rate of capital accumulation and thus of economic progress.

--L. M. Lachmann, "The Market Economy and the Distribution of Wealth," in On Freedom and Free Enterprise: Essays in Honor of Ludwig von Mises, ed. Mary Sennholz (1956; repr., Auburn, AL: Ludwig von Mises Institute, 2008), 175-176.