Barack Obama's Road to Ruin Economic Policies

By: Gerard_Jackson

In order to deal with Obama's economic illiteracy we need to grasp some fundamental economic theory. Let's begin with Obama's ridiculous belief that increasing government expenditure and taxation can stimulate growth. First and foremost, economic growth is a process of capital accumulation. It is this process that raises real wage rates and thus living standards.

Now Keynes gave us Y=C+I+G (this is for a closed economy). It can be seen from this statement that if investment falls national income can still continue to rise so long as aggregate spending rises. This leads to the absurd conclusion that a 100 per cent profits tax would have no effect on GDP so long as it was offset by an increase in one or both remaining variables.

Another problem is that GDP does not represent total economic activity. It is a net value result that omits the massive amounts of business spending among firms on the ridiculous ground that this would be double-counting. The result is that consumer spending is greatly exaggerated, coming out at 66 per cent to 70 per cent of 'total spending'. Once we take total business spending into account consumer spending as a proportion of economic activity drops to about 30 per cent of total spending. (The American Bureau of Economic Analysis has been using this approach for years).

I realize the preceding is pretty heavy going but it is necessary to plough through it if we are to successfully refute Obama's economic fallacies. To continue. As genuine growth is a process of capital accumulation (capital being producer goods that are usually called capital goods) it is clear that any spending that is diverted to consumption must come at the expense of further economic growth because it comes from "forgone consumption". In other words, we consume less today in order to consume more tomorrow. As Professor Beckerman put it, we need

. . . To sacrifice some consumption today in order to enjoy a higher standard of living in the future. (Wilfred Beckerman, Two Cheers for the Affluent Society , St. Martin's Press 1975, p. 7).

Obama's spending plans will divert hundreds of billions of dollars toward government consumption. There is absolutely no way this could be done without damaging future investment. Unfortunately it seems that most economists take a one dimensional view of this process, focusing their attention on taxing and spending. But there is a very important third element that has to be taken into account and one which Hayek stressed:

An increased supply of money made available directly to consumers would cause an increase in the demand for consumers' goods in relation to producers' goods , and would thus raise the prices of goods of the lower order in relation to those of the higher order, and this would inevitable bring about a shortening in the process of production [italics added]. (Friedrich von Hayek, Prices and Production , Augustus M. Kelly, 1967, p. 134. There is also Hayek's Profits, Interest and Investment , Augustus M. Kelly, 1975, pp. 255-265).

Hayek's analysis is based on the fundament fact that at any point in time an economy has a both a capital structure and a price structure. Anything that seriously disturbs the price structure will also impact on the capital structure and vice versa. Hayek used a table to help explain how increased consumer spending can divert investment from the higher stages of production to the lower stages of production.(Ibid.)

The consequences of this process is that investment in the higher stages will be reduced in favour of more consumption, which also includes government spending. This means that real wages and living stands will be lower than they would otherwise be. Taken too far and it will bring about an absolute fall in in living standards. And this is exactly the direction the US will go if the Democrats are able to engineer a massive increase in government spending.

(The Bush administration's own spending record is a disgrace that inadvertently gave the Democrats more political leverage with respect to taxes and spending. What most Republican Congressmen apparently fail to grasp is that increased spending by a Republican administration is always treated by the media as reckless while increased spending by Democrat administrations is always portrayed as compassionate).

The effect of increased government spending on the capital structure — which consists of complex stages — would not be reflected in GDP figures, at least not immediately. These things always take time to make themselves felt. (It seems to be a little known fact that consumer spending continued to grow during the last recession even though business spending dived).

Of course, Obama's economic advisors could argue — as so many economists do — that John Bates Clark and Frank Knight explained that in reality capital is a permanent and self-maintaining fund. If by some mysterious force capital is indeed self-maintaining then it must follow that Obama's massive spending and taxing proposals would not have any detrimental consequences for the quantity of capital and its structure.

The Clark-Knight fallacy also leads to the conclusion that production and consumption are synchronized simultaneously (John Bates Clark, Essentials of Economic Theory , The Macmillan Company, 1924, pp. 18-19 and p. 29), time plays no role in production and capital has no structure. No wonder Hayek called called it "pure mysticism". (Friedrich von Hayek, The Pure Theory of Capital , The University of Chicago Press, 1975, 2007, p. 106). Treating capital as a self-perpetuating permanent fund also means that capital consumption is not possible. Fritz Machlup responded to this view with the observation:

There was and is always the choice between maintaining, increasing, or consuming capital. (Fritz Machlup, Professor Knight and the "Period of Production" , The Journal of Political Economy , October 1935, Vol. 43, No. 5, pp. 577-624).

Machlup's point should have been devastating because his rejoinder in part was based on the dreadful economic and political experiences of his native Austria when the kind of 'progressive policies' that Obama and his fellow Democrats support were implemented*. He calculated that from 1918 to 1930 Austria lost something like 79 per cent to 87 per cent of its capital. This caused him to caustically comment that

Austria was successful in pushing through policies which are popular all over the world. Austria has most impressive records in five lines: she increased public expenditures, she increased wages, she increased social benefits, she increased bank credits, she increased consumption. After all those achievements she was on the verge of ruin. (Fritz Machlup, The Consumption of Capital in Austria , Review of Economic Statistics, II , 1935, p. 19).

For those readers who have got this far, I know it has been heavy going but it needs to be emphasized that in dealing with the likes of the Democrats one needs more than statistics, vital as these are. On needs to completely destroy the 'intellectual' foundations upon which the Democrats base their economic policies.

Although relying on statistics might work in the short run it is the equivalent of building on sandy foundations. I believe this is why a Republican Congress abandoned economic principles in favour of cheap populism. It simply did not understand — or cared to learn — how these policies could come to present a serious threat to America's institutions and its capital structure.

*A great many people overlook the fact that markets are forward looking. This means that the threat of an Obama victory could be enough in itself to put future investments on hold, particularly if these investments were to be funded by venture capital. One of the things to look for in support of this possibility would be a slowdown in IPOs; another thing would be a drop in the number of venture capital-based startups.

By Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes' economics editor.

Copyright © 2008 Gerard Jackson

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