Gov’t spending and public wealth

“When the government spends more, the public spends less. Public works are not accomplished by the miraculously power of the wand. They are paid for by funds taken away from the citizens”- Ludwig von Mises, Human Action: A Treatise of Economics.

In this article, I would like to analyse on why government spending is a bad economic practice and the impact of employment of public expenditure/investment does nothing to increase public wealth.

The Keynesian economists and politicians think that if the private sector is unwilling to spend or risk investment, then the government’s role is to step in and spend or invest. They agree insofar as they see government spending as the most effective method to create a new level of wealth creation.

The market economy is nowhere neat and simple as statistical and mathematical model suggest. It is a genuine relationship of various people, various coordination and discoordination forces, scarcity, subjective value, various capital movement and billions of price formations.

In the opinion of Austrian economics, there is no such thing as public expenditure of government, only consumption expenditure. Then one must make a distinction between productive expenditure and consumption expenditure. While one should praise productive expenditure as an agent for economic growth, consumption expenditure leads to economic disaster.

Productive expenditure is expenditure for the purpose of making subsequent sales. It is the expenditures made by business firms in buying capital goods of all descriptions and in paying wages. Capital goods include machinery, materials, components, supplies, advertising etc. It does not constitute using up of money because the money are productively expended with the addition of profit.

Consumption expenditure is expenditure not the purpose of making subsequent sales but for any other purpose than selling. It does constitute a using up of money and money that are expended, either do not return at all or return only in smaller amount, eventually simply consumed.

The logic goes like this; both a restaurant and my mother buy chickens. The restaurant cooks the chicken, serves it and paid for it by customers who eat the chicken. The money the restaurant used to buy chicken is returned with the addition of a profit.

In the restaurant’s context, they have not consumed (replaced) its money but instead they have obtained additional money which available for other purposes probably expanding its business or more consumption expenditures in future. The restaurant’s expenditure is both self-sustaining and able to make next purchases of goods. Therefore, this is known as productive expenditure.

Let us look at my mother now. My mother cooks the chicken, serves it and not paid for it. The chicken simply disappears in the physical consumption of my family. Just with that, money is simply used up and gone forever.

Capital goods

If my mother want to buy chicken again, she needs fresh money from outside sources which in the context of government, of course, the source is collection of taxes. Therefore, this is known as consumption expenditure.

Similarly, both my mother and laundry buy washing machines. For laundry shop, every time the machine is used, it is paid for this use. The laundry then obtains the payment, then use the money to pay for repairs of the machine probably buy new machine.

My mother does not receive any payment for the use of the machine. From a physical standpoint, the washing machine is productively consumed, making cloth clean. Despite the similarities, bear in mind that they represent two fundamentally different activities in respect to their economic significance.

Having said that this does not change the fact that my mother with the expenditure on chicken and washing machine are unproductively bringing any money as in the case of restaurant and laundry shop.

Of course, in the case of the restaurant and laundry shop, it happens that productive expenditures are sometimes accompanied by losses. That’s normal – profit and loss in capitalist system.

Closely related to the impact of public expenditure is the concept of capital goods and consumers’ goods. Capital goods are goods purchased for the purpose of making subsequent sales while consumers’ good are goods purchased not for the purpose of making subsequent sales.

The principle which one is capital goods and which one is consumers’ good depending only the individual alone and the purpose for which they are purchased. For example, a box of cornflakes purchased by the restaurant is a capital good. Knives and forks, tables and chairs are purchased by the restaurant are capital goods.

A house purchased in order to be rented out is a capital good, one purchased in order to be occupied by its buyer/owner is a consumers’ good. A tractor purchased by a construction company is a capital good, a tractor purchased by the government is a consumers’ good.

Public expenditures such as government offices, hospitals, school buildings, courthouses, military bases, fire houses – all these are consumers’ goods and consumption expenditures because they are not operated for the moneymaking.

The distinction between capital goods and consumers’ goods applies equally to labour. Labour employed (its employer) for the purpose of making subsequent sales is producers’ labour. Labour employed (its employer) not for the purpose making subsequent sales is consumers’ labour.

Multiplier effect

For example, an executive employed by my company is producers’ labour, one employed by Jabatan Kebajikan Masyarakat Sarawak is consumers’ labour. An operator employed by Taiyo Yuden is producers’ labour.

All government employees from judges, army generals, school teachers, policemen whether their services are necessary and beneficial or not are consumers’ labour. Because the payment of their wages uses up the government’s revenue rather than providing the government with the means of earning revenue. To maintain their operation, the government must turn to taxes.

Another false premise of massive government spending is the multiplier effect. It is the claim of a given Ringgit in spending lifts the economy’s output of final goods and services, i.e. Gross Domestic Product by a multiple of the increase in expenditure. In other word, the expenditure by one person becomes the income of another person.

The truth is that as I argued earlier, government spending is merely a consumption expenditure. Thus raise the question of which is multiplier effect? Multiplier effectively denies the irrefutable economic law that new money benefits the first users but those farthest and wider circle of general economy like poor people will lose because the money dilutes the value of each unit money they are holding later.

Second, to have income for consumption one must first produce something useful that can be exchanged in the market. Thus it raises the question, can the lifting of consumption without a prior increase in production set the process of wealth creation?

Market economy is human activity. Individuals engage in production from which they earn incomes by selling what they do not consume. My father for instance, a pineapple planter, exercises his demand for one chicken and one pair of garden shoes he is transferring six pineapples to chicken farmer and 10 pineapples to shoemaker.

My father’s saved pineapples coupled with other consumer goods maintains and enhances the life and well-being of the chicken farmer and shoemaker. Likewise one saved chicken and one saved pair of shoes coupled with other consumer goods maintains the life and well-being of my father.

If some of these saved production is exchanged for better tools and machinery i.e, productive expenditure, once these tools and machinery are built it enables an increase in the productive of consumer goods thus increase the flow of production and rise more savings.

Let us imagine in an economy where my father, the chicken farmer and the shoemaker, another individual enters the scene, government man. The government man is an evil creature who is exercising his demand for goods by mean of force.

Can such demand give rise to more output? No, it will weaken production. My father, the chicken farmer and the shoemaker will be forced to part with their product in an exchange for nothing than weakening the flow of production. Government spending does not give rise to an overall increase in output and income. More money will not change anything because the only function of money is to facilitate the exchange of goods and services. Money is not wealth, production is wealth.

In conclusion, government spending/investment does nothing to increase public wealth, it leaves the people or even the government poorer by the amount of taxes it has collected and expended. This is why, to continue the activity, government must resort to collect more and more taxes from the people.

Medecci Lineil is an Austrian Libertarian who lives in Kampung Tematu, Kuching, Sarawak. He also a Board Member at Institute for Leadership and Development Studies (Lead) and former senior executive at Institute for Democracy and Economic Affairs (Ideas).