Sunday, November 6, 2011

Significantly cutting wasteful government spending will not cause a recession

I'm tired of the same old BS from political pundits that cutting the federal budget will cause a recession. This kind of thinking stems from faulty logic that suggests (incorrectly) that there is a positive multiplier effect of government spending. Once you realize that money is the capability to do mechanical or electrical work, then you'll realize that, on the average, US government spending has a negative rate of return on work invested because a lot of the US government's spending goes into projects with no return on work invested, including but not limited to: paying people to not work, paying people to do the equivalent of digging and filling holes, paying people to build bridges to nowhere, paying people to enforce drug laws, paying people to collect other people's taxes, subsidizing the consumption of prescription drugs, paying people to estimate the future of the economy (which they can't do at all), subsidizing solar energy projects that consume more work building and installing the panels than they generate in electrical work throughout the lifetime of the power plant, subsidizing ethanol blending in our gasoline, and finally, but not the most or least wasteful, paying people to count the amount of gold in Fort Knox.

Let me demonstrate the fact that most things we do will have a negative rate of return on work invested (and especially most of the things that the US or other governments spend money/work on.) I'll demonstrate this with a thought experiment that you can actually go out and do yourself.

Let's say that you are given 1 MegaWatt-hour (MWh) of electricity.  (You could try yourself by buying ~$100's worth of electricity, and then "investing it" in one of the following options.)

You can a) store the electricity in some batteries you own, b) use the electricity to purchase gifts for your family and friends,  c) give the electricity to the government to spend, or d) invest it in a private electricity generating company (for example, NRG Energy.)

What happens in each case after 1 year?
a) After one year, the amount of electricity in your batteries will probably have drained out and you will be left with no electricity. (Though, if you had used your money to purchase ~$100's worth of gasoline, you'd have roughly the same amount of capability to do work as at the beginning of the year.)  Option A (i.e. sitting on electricity or fuel) leads to a negative or zero rate of return on investment.

b) In the case of the gifts, let's assume that 60% of the electricity you give to the store owner to purchase the gift goes into making the gift and 40% of the electricity goes to the store owner so that he can raise his family. How much of the original 1 MWh of electricity is remaining after a year? It depends on what the store owner does with the electricity. In our non-growing society (i.e. our sadly ~0%/yr growth society), there's a ~50% chance that the store owner will invest the electricity into something with a positive return on work invested and a ~50% chance that he will invest in something that doesn't have a positive return on work invested. So, if you purchase a gift, there is likely to be a significant net reduction in the amount of electricity available by what I'm guessing is ~60%. Option B (i.e. the consumption of luxuries) leads to a large negative rate of return on investment.

c) In the case of giving your money to the US government, you might see some mixed results depending on where the government spends the money. If they spend it on a bridge to nowhere, then there will be no electricity remaining from the 1 MWh you gave the government. If the government spends the money on US veteran's health care, there's the chance that the money could be used to save somebody's life that could be a productive member of society. If the government spends the money (i.e. electricity) on energy R&D, there might or might not be a return on money (electricity) investment depending on where they chose to invest, but over the last 40 yrs the US government has done a pretty bad job of picking winners in the energy field.  (Recently, the US government has been propping up failing firms like Solyndra and Range Fuels, and totally missed out on investing in the successful natural gas companies like Chesapeake and Range Resources.) If the government spends the money paying people to not work (or on any of the other options listed at the beginning of this post), there is no direct return on work investment. On average, Option C (i.e. government spending) leads to a negative rate of return on investment.

d) In the case of the private electricity company, you can actually increase the amount of electricity you own. If you invest in a well-run company, you might have 1.1 MWh's of electricity after the end of the year (i.e. a 10%/yr after tax rate of return on investment.) From this 10%/yr rate of return, you could afford to take out 10%/yr to spend on luxuries for yourself or your family if you are not interested in growing your money. You could leave all of your money in the company and watch it grow by ~10%/yr. Or you could afford to take out 5%/yr if you would like to have a balance between growth and buying luxuries for your family. On average, Option D leads to a positive rate of return on investment.

So, we reach the final conclusion:  Significantly cutting wasteful government spending will not cause a recession because spending money on wasteful government projects will lead on average to a negative rate of return on work investment (i.e. this type of spending consumes electricity and fuels that other people worked hard to produce.) In fact, if we instead cut wasteful government spending and increase taxes on luxury items, we will encourage people to invest more money into energy companies that will generate a positive rate of return on work invested. The net result of cutting wasteful government jobs and increasing taxes on luxury items will be the following: a) elimination of our yearly national deficit and b) a growing society with a growing number of jobs.

This is something that we can achieve (without needing the gov't to tax luxuries) if we each do our part to reduce our consumption of luxuries and increase our investment into 'energy' companies. (Note: I'm not going to suggest which 'energy' companies to invest in. You should do your own research to find out which 'energy' companies are under-invested and to decide where to invest your hard earned money.)

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