The idea is to give people the means to purchase goods, so as to create the necessary demand for producers to produce. The underlying assumption is that sufficient demand is lacking. Feed the bottom, then watch the economy grow. Trickle-up economics.
This is the dominant economic view today, developed and promoted in the 1930’s by Lord John Maynard Keynes. In Keynes’ theory, the state plays a central role to maximize production, achieve economic stability and assure full employment. In his view, the free market lacks the requisite compensatory mechanisms to achieve these goals. Instead, the state must intervene through the manipulation of taxes and interest rates, and by “investing” in infrastructure and other public projects.
From this point of view, the fundamental problem of economics is a lack of “aggregate demand,” i.e. not enough ability to consume.
But the need to consume is a fact of nature. We are born hungry, naked and poor. The fundamental problem of economics to be solved is not the creation of more need or desire or ability to consume. We are born with a limitless need for wealth. The fundamental problem to be solved is production. Without production, there is nothing to consume. With production, and free market competition, the interaction of supply and demand results in goods and services at affordable prices. Free market prices are the “requisite compensatory mechanism” which Keynes failed to see.
We can not improve the general standard of living simply by boosting consumption. The apparent chicken-and-egg of production and consumption has an essential fulcrum: the productivity of labor. Progress in prosperity is only made by figuring out and applying ways to do more with less. More goods with less effort and/or less material.
Increasing the productivity of labor makes the real cost of goods go down. As labor is valued by how productive it is, through increasing the productivity of labor, you also increase real wages. Cheaper goods and higher wages are the source of true prosperity and progress.
How do you increase the productivity of labor?
Not by handing consumers more spending money through a stimulus package. That approach fails on two accounts. First, consumer spending is a relative dead end. Items are purchased, enjoyed and consumed. Some businesses benefit, but the effect soon peters out, unless the stimulus keeps coming. Since the money has to come from somewhere, without production, this method is unsustainable. Second, where does the stimulus money come from?
Money is simply, stored wealth. To be stored, wealth first must be produced. So money for a government stimulus (or any type of government redistribution) must come from production, either directly via taxation, or indirectly via debasement of the currency (by increasing the national debt or simply printing more paper dollars) which then erodes away the value of our savings. To “invest” in consumer spending, you first have to subtract from funds which could otherwise be invested in improving production through capital investment. The nature of capital investment is to create the means for even greater production, i.e. more wealth. The nature of consumption is the depletion of wealth.
It is true that increased consumer spending will stimulate some increased production, but without the funds to invest in capital improvements (both human and material) the productivity of labor will not increase, or will increase to a diminished amount. With a stimulus package, some jobs will be created. Some people will be able to purchase more goods. However, the same money put towards capital investment would create even more jobs, and the resulting increased productivity would make even more goods affordable to even more people.
The jobs and goods which never materialize because of government redistribution policy is another case of “What is Seen and What Is Not Seen.” It is easy to see the money we are handed, and the immediate effect on spending. It takes more work to understand the hidden cost on future production and spending, because the goods and jobs that are never created is what we do not see.
This theory is supported by experience. As discussed in a recent article in the Wall Street Journal:
The nearby chart shows the arc of tax policy and economic growth across the Bush years. After the dot-com bust, President Bush compromised with Senate Democrats and delayed his marginal-rate income tax cuts in return for immediate tax rebates. The rebates goosed spending for a while but provided no increase in incentives to invest. Only after 2003, when the marginal-rate cuts took effect immediately, combined with cuts in dividend and capital gains rates, did robust growth return. The expansion was healthy until it was overtaken by the housing bust and even resisted recession into this year. Mr. Bush and Congress returned to the rebate formula in February, but a blip in second-quarter growth has now ended as the economy heads into recession.
Production must precede consumption. This is concretely evident in a primitive economy: the food that is not hunted, gathered or grown can not be eaten. The connection is easier to loose sight of in a complex division-of-labor economy, especially one of paper fiat money. As economist Dr. George Resiman explains in “Production vs. Consumption,”
The use of money makes this point somewhat less obvious but no less true. Where money is employed, producers do not exchange goods and services directly, but indirectly. The buyer exchanges money for the goods of a seller. The seller then exchanges the money for the goods of other sellers, and so on. But every buyer in the series must either himself have offered goods and services for sale equivalent to those he purchases, or have obtained his funds from someone else who has done so.
The fact that in a monetary economy everyone measures his benefit by the amount of money he obtains in exchange for his goods or services is interpreted by the consumptionist to imply that the mere spending of money is a virtue and that economic prosperity is to be found through the creation and spending of new and additional money — i.e., by a policy of inflation.
In rebuttal, the productionist argues that for everyone who spends newly created money and thereby obtains goods and services without having produced equivalent goods and services, there must be others who suffer a corresponding loss. Their loss, says the productionist, takes the form either of a depletion of their capital, a diminution of their consumption, or a lack of reward for the added labor they perform — a loss precisely corresponding to the goods and services obtained by the buyers who do not produce.
The destructive effects of redistributionist policies is not just the loss of wealth that it causes, but the violation of the moral principle that each man is an end in himself and must not be coercively turned into the means for another’s end. Reisman continues:
The only economic benefit which one can give to a producer…consists in the exchange of one's own products or services for his products or services. It is by means of what one produces and offers in exchange that one benefits producers, not by means of what one consumes. To the extent that one consumes the products or services of others without offering products or services in exchange, one consumes at their expense. (emphasis mine)
These two opposite views of economic life have consequences far beyond their effects on GDP, unemployment rates and the affordability of goods. They also define our most fundamental social relationship: free men and voluntary trade, or men controlled by the state in a system based on “from each according to their ability to each according to their need.”