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Is It Better to Save or to Spend?

Banner protesting austerity measures in Brussels, Belgium. Photo by Morgan Till/PBS NewsHour.

Restricted as this page usually is to questions (and answers), its posts can, I realize, seem more than a bit off the news. This is especially true when the economic world is roiling, as it so often has been of late.

So let today’s post be a meditation on the roil and in particular, the center-stage question facing the U.S. and Europe, one that has prompted occasionally heated exchanges on my Twitter.

The quandary is obvious: stimulus or austerity? In economic jargon, Keynesian or the Austrian School? In plainer terms, save or spend? But which is the right answer?

Each side is championed these days, as it was in the last Great Downturn, by Democrats on the one hand, and Republicans on the other — and abroad, by their political equivalents.

This cartoon from the conservative Chicago Tribune in 1934 illustrates the Republican point of view in reaction to the spending of the New Deal.

Obama a “socialist”? Note that the Roosevelt administration (in the runaway wagon) is supposedly “communist”, following the script of the man at the lower left. That’s Leon Trotsky, once a leader of the Soviet Union and its Red Army. By 1934, he had long since been exiled by Stalin and was living in France, but the symbolic value of his image apparently remained vivid enough for the average American. (Or maybe the Trib hadn’t kept up with times.)

Caricature assassination aside, the essence of New Deal Keynesian spending is simple and seemingly sensible: that there’s nothing worse than idle resources and the very worst resource to idle are human beings, for reasons both political and economic. The political cost of idle hands is screamingly obvious: an unemployed, disaffected, meaner citizenry. (See Benjamin Friedman’s major book of 2005, “The Moral Consequences of Economic Growth,” for the damages of contraction. Or glance at Germany after the Great Depression of the early ’30s.)

When citizens lose their jobs, they can’t afford to keep spending. When consumer spending stalls, businesses see no reason to make new investments — “Who will buy?”, the song from “Oliver!”, springs to the mind’s ear. Businesses slow their spending, too.

The quick fix for this problem — for decades — has been lowering short-term interest rates to make borrowing cheaper and thus kick start spending. But it doesn’t work if interest rates are at zero, as they are now. You can’t have a negative interest rate.

Unless you give people money, that is. And that’s the argument for stimulus. Absent the consumer and business, there’s only one Big Spender left, argue the Keynesian Democrats: government, the spender of last resort. It can give people money by cutting their taxes and hoping they’ll spend. And/or, it can give people money by hiring them, as Franklin D. Roosevelt did in the “Trotskyist” New Deal.

So what’s not to love? The inefficiency of government planning, says the free market devotee. How so? Let us count the ways.

1) “Central planners” in government can’t possibly know what people really want, and how much they want of it. That’s information distributed so widely that only a price system can reveal it, as consumers and businesses, in the aggregate, reveal their preferences by what they’re willing to pay. Who knows if that new road is really worth the price? Or even filling those potholes?

2) Government spending is rife with inefficiency because it lacks what the market so providentially provides: a profit motive to keep costs down. Why not pay workers whatever they ask, since they’re the voters who will keep you in office?

3) Even if government spending were justifiable, now is the wrong time to splurge, since it will only add to our budget deficit, thus hobbling future generations.

What, then, is the policy that flows from this critique? Don’t spend but save. Pay down the debts of the manic past. Cut inefficient government spending and endure the inevitable austerity.

Let the economy renew itself via the all-knowing market. (Or at least, more knowing than a bunch of economic “technocrats.”)

This exchange between market champion Russell Roberts of George Mason University and Britain’s famed biographer of Keynes, Robert Skidelsky, captures the conflict.

RUSS ROBERTS: Capitalist economies have slowdowns, contractions, slumps, recessions, and depressions. [And bounce] back fairly quickly without government intervention.

ROBERT SKIDELSKY: [But] there were terrific sufferings. I mean, people, whole communities were uprooted. … I don’t think we can take risks of the kind I think you’re implying. I think the political downsides of taking those risks are going to be too great. And, in Germany, they were absolutely horrendous in the early ’30s.

PAUL SOLMAN: Is that not true?

RUSS ROBERTS: Well, my claim is that, in our attempts to engineer our economy from the top down, we have actually made, in many many cases, the world less secure, workers less secure, and lowered our prosperity, and hurt people.

PAUL SOLMAN: Because, otherwise, the system would have adjusted?

RUSS ROBERTS: Would have done better.

Watch: Keynes vs. Hayek: Late Economists’ Hip-Hop Legacy

That was two-and-a-half years ago. In much of the world, Austrian austerity has more or less prevailed. In much of the world, global politics seem to be proving Skidelsky prophetic. Economics, remember, is the discipline that weighs costs against benefits and insists that there is no such thing as a free lunch. I’m not sure I agree with the latter statement — what else is technological growth if not a free meal of some sort? But as to costs and benefits and the tradeoffs they inevitably dictate, there can be little question. And it’s awfully hard for those of us with jobs to blame the unemployed for insisting that the tradeoffs ought not to come at their expense.

This entry is cross-posted on the Rundown– NewsHour’s blog of news and insight.

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