Is all spending created equal?

There is an interesting debate between Austrian Economist Mario Rizzo, and Neo-Keynesian Brad De Long over at Think Markets on the nature of fiscal stimuli. In particular they differ on the impact of public and private spending, with Mario Rizzo regarding the former as a destructive force building up problems for the future and De Long as a necessary evil to prevent massive unemployment today. Economists and financial commentators from both schools have a good track record of critiquing the economic faultlines of the highly leveraged Anglo-American economies in recent years, which makes this debate particularly illuminating.

(For more information on their track record – see this interview with Paul Krugman (Neo-Keynesian) from 2006 on the US housing bubble, and this speech by Peter Schiff (Austrian) to the US Mortgage Bankers also in 2006. )

Both articles are worth reading –

1. Brad De Long – Kick Starting Employment
2. Mario Rizzo – Is all spending created equal?In the comments section De Long sums up where there is agreement neatly –

So if we both agree that government spending will boost employment in the short run in which employment will be distressingly low, what is your point? I take your point to be that this government spending is wasteful relative to private market demand: that private-sector demand we know will be for things that people want, while government demand has a different and more political logic.
If that is indeed your point, that’s my point–and I was there first….
We would rather have the first if we have the choice—private-sector demand we know will be for things that people regard as useful, while government-sponsored stimulus programmes have a different and more political logic—but we may not have the choice…

Mario highlights his difficulties that arise with the allocation of resources that occurs as a result of government spending, regarding them as a missallocation propping up industries that must fail (e.g. the uncompetitive US auto-industry) and starving other more deserving companies of funds. Politicians will make political rather than economic decisions.

It is important that targeted stimulus (both fiscal and monetary) does not significantly inhibit the re-allocation of resources. Unfortunately, the poltical principle of resource allocation differs from the economic principle. Much of what government, including the Fed, is trying to do will have the effect of slowing down necessary adjustments. This is bad.

Now I fully understand that once a recession gets underway that “the dark forces of time and ignorance” may contaminate all sorts of investment projects including those that will ultimately be justified. This is bad, but no one has the knowledge to know in specific terms, now in the midst of the “confusion,” the difference between wheat and chaff. Yet a discovery process will occur to the extent that the system in not burdened with “regime uncertainty” and obstacles to efficient resource re-allocation.

A few months ago I gave a talk in DC at a Heritage-Club for Growth conference. There I said that one of the virtues of the (marginal) tax reduction approach to stimulus is that the stimulus is directed where consumer-investors want it to go. Thus, it is more likely to generate sustainable lines of output.

Whatever is done, there will be pain. Stimulus that actively prevents or inhibits market adjustments does not solve the underlying problem. Whenever large quantities of resources move from one area to another there is pain.