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Government spending as stimulation is poisonous economic policy

Not all government spending is bad, but using government spending to stimulate consumption as a means to stimulate the economy is bad.

It may have some immediate effect of making it less recessionary, but it is like prescribing steroids to a weak patient. The long-term harm is not only a weakened economy in terms of productivity but also a moral hazard of stealing from future generations because such stimulation’s net effect is always inflation and empty bubbles after the pain relief effect dies out.

People now praise the short-term success of the US coming out of the 2008 recession. Although it was good to save the economy from immediate collapse, it was a reactive emergency handling out of desperation, arising from a situation that was created by prior errors.

Rather than learning the right lesson, the US government became confident. This undeserved and misplaced confidence was one reason why the US government became so blindly and recklessly bold in its remedy for COVID-19: printing and giving out many trillions to “save the economy” and continues to do so to prop up the economy by boosting government spending four years after the pandemic. History will show (and is already showing) that this is the stupidest thing the US government has ever done. It accelerated the collapse of a weakening empire (weakening due to moral declines, pride, laziness, and lack of self-control).

The influence of economic theories

What is even more dangerous is that the US government does not commit those errors randomly. It finds support in economic theories, such as Modern Monetary Theory (MMT) and Balance Sheet Recession theory.

It shows how a seemingly nice economic theory invented by academic economists really harms the economy.

Economist Richard Koo’s Balance Sheet Recession theory is an example. The theory only plays a small part in this, but it is dangerous enough.

The theory correctly DIAGNOSES one of the multiple causes of the recession but PRESCRIBES a fundamentally WRONG REMEDY:

Stimulating the economy through government spending.

The Balance Sheet Recession theory primarily advocates for government spending on the demand side. According to the theory, during a balance sheet recession, businesses and individuals focus on paying down debt rather than borrowing and spending, despite low interest rates. This leads to a significant drop in aggregate demand. To counteract this, Koo recommends that the government step in to boost demand through increased public spending. By doing so, the government can offset the decline in private-sector spending and help stabilize the economy.

Koo argues that supply-side measures, such as tax cuts or deregulation, are less effective in this context because they do not address the core issue of insufficient demand caused by widespread deleveraging. Therefore, demand-side government spending is seen as the key to recovery in a balance sheet recession.

The theory may be good for educating students to do analyses, but it is terrible for policymakers. Artificially enhanced government spending does not produce anything, does not improve the economy’s productivity, and does not improve people’s lives. It is fake consumption and a fake economy. It improves the superficial GDP for its own sake. But it does even more harm than that. It further distorts the market, distorts the natural signal pathway of economic and business feedback for learning and discipline, and produces inflation down the road.

To see the fake nature of such consumption, one may consider an example where the government increases demand and supply in certain sectors by starting a war. The war destroys people’s lives and lowers the quality of life. But it increases the GDP.

Or, one may imagine another extreme scenario: why can’t the government simply create fake demands and fake supplies using fake accounts and fake companies to conduct fake economic activities to boost the GDP? Or better yet, why can’t the government create or allow others to create companies run by AI to produce virtual products that are only useful for other AI but not human beings? This would create an unlimited amount of demand and supply loops that add to the overall GDP. If this sounds ridiculous, how is it fundamentally different from the other types of government spending that are not regenerative or productive but only allow the government to claim the credit for improving the economy by showing GDP growth?

What will China do?

Now, economists are trying to persuade the Chinese government to stimulate the economy through government spending, as the US did.

But if China followed that advice, it would be even more foolish than the US.

The Chinese economy has already been stimulated by government spending. But it did so in a way that was the opposite of using government spending to stimulate consumption. It did it through investment and overinvestment. It seems natural that now the proper countermeasure is to create money to stimulate the economy through consumption.

But it is the worst thing China can do at this point.

Just because over-investment is the problem does not mean that consumption stimulation is the solution.

Healthy demand-side is emergent, not fundamental. It is a natural outcome of a balanced and regenerative economic distribution, not a result of artificial stimulation. This is true for all aspects of the demand-side, including consumer, business, and government.

However, a balanced and regenerative distribution is the most complex and hardest to achieve. It isn’t smart to think that artificial consumer stimulation can result in a more balanced and more regenerative distribution system. It may create a temporary appearance of better distribution, but it does not create a balanced and regenerative distribution system.

As a result of overinvestment and deep-rooted political and cultural structures, China has one of the most frugal distribution models if measured by consumption level versus savings and investment. It was this intentionally unbalanced distribution that drove the fast growth of China’s economy in the last 40 years.

But it has come to an end.

You cannot drive long-term growth using continuous overinvestment without a balanced and regenerative distribution. The latter is a systemic prerequisite of a healthy economy that has synergistic supply-side and demand-side.

The investment model may be regenerative in the beginning but will become less and less so. The problem is inherent to any system that has inherent input-output restrictions.

At this point, more investment will not drive fast growth in China because the system is no longer able to productively absorb overinvestment.

But stimulation using government spending is not the right solution either. It is like quenching the thirst with poison. It is a disease. Stimulation by government spending cannot fix the disease. Without deep reform, the only thing China can do to temporarily mask the symptom is to export the surplus of its supply side. But doing that creates mirroring imbalances in the receipting nations. If the other nations are foolish enough to allow this to continue, not knowing such imbalance impoverishes them in the long term, the export strategy would continue to work for China. But can anyone pretend to be surprised if the others start to complain?

It is a cliché, but it is still the truth: the Chinese problem is structural, deeply entrenched in the political and cultural structures.

Facing the present challenge, China has roughly three choices:

Choice 1: Pushing for deep political reform, along with economic reform and cultural reform

Choice 2: Sticking with the current model to maintain the industrial strength as a nation at the cost of individual and family income growth

Choice 3: Printing money to stimulate consumption to maintain high GDP growth artificially.

The above three alternatives are not equivalent.

The first choice is the best choice but also the hardest and the least likely. It requires reforms that contradict the very foundation of China’s current political system. It is unlikely to happen, barring some unexpected historic turns.

The second choice is less beneficial to people, but it may be an attractive choice for the Chinese government because it fits its philosophy of collectivism, which in this particular scenario means compromising people’s welfare in preference to national strength (i.e., strong nation but not-so-well-off people). It is not ideal and may also threaten the legitimacy of the current political regime in China because it has long promised fast growth, but it may be able to manage to meet the current Chinese political and national narrative for quite a long time.

The third choice is the worst but also the easiest. It can be an effective painkiller but will eventually kill the system. Economists recommend this path because they automatically equate GDP growth to a good economy without questioning the premise.

But will the Chinese government also be fooled? It’s hard to say. They seem to still have common sense about fiscal discipline and long-term preservation. They haven’t become a total victim of the religion of consumerism yet. And being an autocracy, they may also be less susceptible to the temptation of committing mass voter bribery through printing and handing out money. But none of these factors is determinative. Sometimes, the imminent pressure can be so high it may override the sense of long-term preservation.