A lesser economic evil

The Jerusalem Post
2 Feb ’09

All government deficit spending is bad.

But sometimes deficits are unavoidable.

And some deficits are better then others.

Filed under:

financial markets • public policy • taxes

Most politicians treat the world economic meltdown threatening Israel as if it is happening on the moon. So it is comforting that the candidates for prime minister recently described what steps they would take to forestall a terrible crisis.

The three agreed that because of the paralysis afflicting financial markets, which threatens to turn a recession into a deep depression, liquidity should be quickly injected into the system and consumer spending encouraged. This requires a significant increase in the government’s budgetary deficit. But the candidates disagreed about how to make use of the deficit.

Both Tzipi Livni and Ehud Barak want government to increase its direct expenditures. Livni is vague about how. Barak wants increased government spending on security, health, education and, of course, infrastructure. Labor and its allied oligarchs have always greatly benefited from government spending, even when it damaged the economy.

The problem is that government is already overspending in all these sectors. More spending would not enhance economic activity, except perhaps marginally. It would, more likely, increase inefficiency and waste, two hallmarks of our bureaucracy. More government spending would help certain favored sectors dominated by our oligarchs, but would lower productivity as more and more resources are diverted to an inefficient and wasteful public sector and monopolies.

It is also doubtful whether an ambitious government infrastructure program could quickly create more jobs. Such projects take years to plan, and government usually implements them with great delays and cost overruns through politically connected contractors who are experts at bilking the public purse.

BINYAMIN NETANYAHU, on the other hand, proposes to create a stimulative macro-environment for firms by lowering business taxes across the board, since sectoral preferences often distort economic considerations. He also proposes lowering taxes to enable individuals to both consume and save more. The advantage of increased individual spending is that it enhances decentralization and competition. Consumers buy from a large variety of manufacturers meeting different needs and offering the best prices – namely, the most efficient. Consumer spending thereby increases economic choice and efficiency.

In contrast, direct government spending increases economic concentration since politicians prefer big business. It enables them to better control the economy and helps them raise campaign contributions. High costs and lack of access further limit participation of smaller firms in government tenders. This is why big business and its many cartels dominate the economy, and the country suffers from a concentration of economic and political power. Concentration leads to less competition, widespread inefficiency, inflated prices and the corruption both of politics and the economy.

A CRISIS CAUSED by a world wide economic contraction leading to shrinking demand will impact harshly on an export-dependent Israel. Therefore, it may not be wise to extend government intervention through yet more direct government spending. It will only make the country even less competitive than it already is, with disastrous results.

If government nonetheless decides to engage in direct expenditure, it should do so only on focused, well-defined projects, such as basic research. Basic research must initially rely on public funds: until it can be incorporated in products, it has little economic value and cannot attract investment. So Netanyahu is right in proposing such government help.

Netanyahu is also right in insisting that emergency government expenditures are not sufficient (as the failure so far of huge US government expenditures to stimulate its economy demonstrates). To enhance economic productivity and competitiveness, Israel must engage in basic reforms in its land, energy, electricity, water and ports, sea and air. All these sectors suffer from gross inefficiencies and low productivity, inflated wages and featherbedding. Their reform will require a brutal political war with the influential politicians who represent our oligarchs and other vested interests, such as the powerful public sector monopoly unions. A rough fight will also be required to complete the the partial (though already most beneficial) reforms in financial markets which bankers and their allies in the media are trying to roll back. It is most unlikely that either Labor or Kadima will combat these powerful constituencies.

THE POLITICAL BATTLE on how to use government deficit spending reflects an ideological battle between the adherents of Keynesian economics and free market skeptics. Keynesians believe that only governments can prime the pumps of an economy in severe recession or depression. Skeptics doubt that governments, no matter how well intentioned, are capable of such action even in a remotely efficient way.

While conceding that tax rebates do not always translate immediately into additional consumption (Milton Friedman demonstrated that consumer spending is based on a notion of “permanent income” and not on changes such as those created by temporarily lowered taxes), market advocates still insist that governments, even if ideally suited for the huge task of priming an economy, are not in reality capable of doing so in a measured or effective manner. Political pressures force governments to overshoot and support inefficient “rent seekers,” such as monopolies and cartels. And indeed wherever Keynesian measures were undertaken, the results (as Noble Laureate Robert Barrow recently demonstrated in a study of the New Deal) were disappointing – even disastrous. They resulted in little economic growth while generating high inflation or stagflation.

This may be because “government” or “public” funds are really private resources taken from individuals as taxes or loans. Their use by government usually means a shift from productive to wasteful and inefficient use.

The results are predictable, and they are usually not good. The policy choice for Israel is clear.

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