Peter Smith

Magic Pudding Economics

puddingIt is clear the economy is going through an adjustment phase. The latest trend employment numbers — those stripped of monthly variations and largely of sampling error — show employment growth of only 0.3% in the year to January; versus, say, 1.4% in the year to January 2012. The working-age population is growing at around 1.5%. The gap is a problem.

No doubt the latest numbers will reinforce the views of those who believe that now is not the time for the government to rein in its spending.  Joe Hockey, are you listening? I hope not.

The slowing of the investment phase of the mining boom, the high-profile car company closures and the weakening labour market have come together to bring out the latent Keynesianism in economists, also in commentators who have not studied a word of economics but ‘know’ somehow that spending is good.

History shows that the time is never right to cut government spending. In buoyant times when tax revenue is pouring in it would seem churlish not to spend a good chunk of it on entitlements, worthy measures and projects. The Howard government showed that even if it was among the more measured and prudent governments we have had. When times are tough and tax revenue dries up, we are told that cutting government expenditure is exactly the wrong medicine to apply to a struggling economy.

This spending business is almost hardwired into intelligent and educated modern minds. This is because it seems so bleeding obvious. If government and people spend money business does well, doesn’t it? You have to wonder why some of the greatest minds of the past – among others, Adam Smith and John Stuart Mill – just didn’t see it. They must have been nincompoops, wrongly accorded the status of intellectual giants, to have missed the obvious throughout thousands of words of reasoned argument.

That spending drives economic growth is an all-pervasive conventional wisdom. Ergo, government spending and consumer spending are good. Wage rises for workers are good. Don’t forget that the economy benefits as those wages are spent. On the other hand, rich people don’t spend as much of their income. That’s bad.

Really? You mean paying higher and higher wages to people who will spend all their income benefits the economy? Yes, it’s called Magic Pudding economics — “The more you eat the more you gets”– and was discovered by Norman Lindsay ahead of Keynes. Unfortunately for Norm he never got the credit.

How can this economic fallacy be countered; fortified, as it is, by Keynesian sham-economists of undeserved reputation?  I have to admit to not knowing. John Stuart Mill exhibited frustration with it in his day. If JSM didn’t manage to permanently rid the world of it I doubt little old me will.

It is a question of how you look at economic forces. If you think you can eat coconuts and fish on a desert island before you pick and catch them, then you march in step with the conventional wisdom. Embrace economic nonsense. Be bereft of economic sense. On the other hand, if after deep consideration you think the picking and catching comes before the eating, if you adjudge that spending income is a derivative not a driver of production and prosperity, line up behind JSM.

What this will mean is that you will distinguish between making value and consuming value. You will recognise in your own personal life that making money is harder than – and has primacy over – spending it and apply this insight to the wider world.

Leaving aside well-considered infrastructure spending, government spending simply uses up resources. It is true that businesses adjust to patterns of expenditure and will be disrupted when particular categories of expenditure cease. However, this is an adjustment problem. It has to be faced up to.

In the end result less government expenditure means that resources are available to meet market-determined needs. Value is created, not just used up, and prosperity rises as a result.

The signals which get this process going are powerful. Less government expenditure means lower interest rates and the prospect, if not the immediacy, of lower taxes. These signals become more powerful the fewer are regulatory obstacles to business development and growth.

Fat, bloated and wasteful, it is always the right time to rein in government expenditure.


Peter Smith, a frequent Quadrant Online contributor, is the author of Bad Economics

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