Thursday, September 13, 2012

Fallacy of Government Stimulus

Here's the simplest line of reasoning why goventment stimulus doesn't work:

(1) The economy grows when power plants self-replicate. The higher the rate of return on work invested (IRR), the faster the growth rate of the economy.

(2) Power plants that can self-replicate with large 'unsubisidized rates of return on work invested' don't need a government stimulus to self-replicate (by definition).

(3) Government stimulus comes from (a) borrowing from today's investors by promising future direct taxes to pay off the loans, or (b) indirect taxes on present investors (by printing what the Federal Reserve is doing right now.) The direct or indirect taxes lower the inflation-adjusted growth rate of those power plants that can self-replicate because some of the project's profits go to paying taxes (both directly and indirectly) rather than re-investing the money into self-replicating power plants.

(4) Some of the government money goes to projects that are barely self-replicating (only with the government assistance) and some of the money goes to projects that are not self-replicating (even with the government money.) Either way, the government ends up picking projects with lower 'unsubisidized' rates of return on investment than would an individual or a company. (Note that individuals and companies aren't perfect at knowing where to invest, but on average throughout history, individuals and companies choose projects with higher rates of return on investment than do government agencies. This is true across the globe. It's true in the U.S., E.U., China, and Japan. Higher average growth rates occur when the government makes less decisions on where to invest.)

(5) There is friction associated with the act of taking money from one project and giving it to another project. The friction (i.e. money that goes to pay the salary of tax collectors and government bureacrats) consumes useful work, which means: not only is the government picking projects with lower 'unsubsidized' rates of return on investment, but the very act of picking projects with government agencies requires taxing self-replicating power plants to pay for the government agencies. It's like a double tax on self-replicating power plants: a tax to subisidize the un-self-replicating project and a tax to pay the government tax collectors and government bureaucrats to choose what project to subsidize.

(6) Therefore, government 'stimulus' lowers the growth rate of the economy by taking money from projects and power plants that are self-replicating and giving the money to projects that are marginally self-replicating or that are not self-replicating. Money is transferred from power plants with large positive values of rate of return on investment to projects with marginal or negative 'unsubsidized' rates of return on investment. Since the growth rate of the economy is a weighted average of the growth rate of each of the individual projects, when governments take money from projects with large growth rates and give the money to projects with low to negative growth rates, the overall weight average growth rate of the economy is less than if the government did not take money from the projects that naturally have high growth rates.

The conclusion, therefore, is the following: let individuals and companies decide where they want to invest their money. Let the government focus on what it's supposed to be doing according to the constitution and the updated bill of rights.

1 comment:

  1. Note that there are ways for investors to avoid the indirect tax of when the Federal Reserve prints money.
    But to do so, you have to be investing your money rather than having it sit in a checking or savings account. Printing money is basically a tax by the Federal Reserve on those people who keep their money in checking and savings accounts. In my post on Energy Banks, I outline one way of avoiding the inflation tax.