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Economics
: A Post-Mortem Necessary PART V: What can Cure Economic Depression can surely avert Recessions! by Sophia Barkat Abstract: Keynes and FDR used Government Spending to get the US Economy out of a Depression. Why not a Recession? Paper shows that while 50% drops in GDP were cured by FDR's public spending programs, today's politicians shy away from responsibility, as though Government Spending cannot fix small deviations from the 3% GDP Growth target. The Paper: Since by definition, GDP or Output (Y) = Personal Consumption (C) + Gross Domestic Private Investment (I) + Government Spending (G) + Net Exports (X) and G has been used to fight the Depression and Recessions, why do Governments just not use G to correct GDP so that we never have recessions? To understand the role of Government Spending a brief look at its history is important: # The History: In 1929 the US Agricultural Sector faced a crisis. Prices were falling due to excess supply and farmers were beginning to starve due to the lower prices. Franklin D. Roosevelt, troubled by this crisis in one of the main business sectors, decided to burn crops to raise the price of crops. He succeeded in raising the price of crops back up, but it was just the beginning of a series of projects to come. Worried by FDR's shortsighted approach, John Maynard Keynes wrote a series of open letters to Roosevelt, hoping to replace the crop burning with a better long-term plan for Government Intervention: http://www.ehcweb.ehc.edu/faculty/balove/inweb/courses/225/keynes%20to%20roosevelt.pdf Kenyes, talked about "Recovery and Reform -- recovery from the slump and the passage of business and social reforms which are long overdue.....Wisdom of long-range purpose is more necessary than immediate achievement." "...the object of Recovery is to Increase the national output and put more men to work," Keynes wrote to explain what he was really getting at. That Government intervention should result in people having jobs and income. "Individuals must be induced to spend more out of their existing incomes or the business world must be induced , either by increased confidence in the prospects of by a lowering of rate of interest, to create additional current incomes in the hands of their employees, which is what happens when either the working or the fixed capital of the country is being increased, or the public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money." Thus Keynes created the concept of Government Spending for peacetime and not war financing, as was the norm, an idea that resulted in the Roosevelt Administration creating millions of jobs for jobless Americans. Keynes was a major proponent of raising funds for Government Spending via borrowing from the people, primarily the rich, instead of via taxation. Unlike those who thought that growth of Output could be achieved by increasing Money Supply, he suggested that unless the demand for money rose, increasing money supply would amount to nothing. This is why he proposed the Government create a "Public Works" program, to create jobs and to push money back into circulation. The US Government and governments worldwide have used this idea of Keynes to boost output. # How has G changed as a percentage of GDP between 1929-2002? See Table 1.1, Gross Domestic Product (Annual 1929-2002) at http://www.bea.doc.gov/ In 1929, Government Spending was 9% of GDP. Between 1929-33 GDP fell from $103 billion to $56 billion -- by almost 50%. A fall in Personal Consumption accounted for 2/3 of that fall in GDP and Gross Private Domestic Investment for the rest. The economy recovered in 1940, thanks to a steady rise in Personal Consumption as well as Gross Private Domestic Investment, and doubling of Government Spending. Between 1941-44, Gross Private Domestic Investment actually fell due to WWII, though G skyrocketed to $105 billion from $15 billion. The end of the War saw a sharp rise in both Personal Consumption and Gross Private Domestic Investment with the reduction of G back to $40 billion in 1946. Since then, all three, G, C and I have only grown, with G outgrowing I since the 50s. G accounted for 1/4th of GDP in 1960, 23% in 1970, 20% in 1980, and less than 20% in 1990, and just 12.5% in 2000. And yet, actual G has grown from $9.4 billion in 1929 to $1973 billion in 2002 -- a rise by almost 200 times 1929 figures. The rise in G has also compensated for the fall in Net Exports, with Net Exports turning negative in the 1975 and never going positive again, as the US became a net importer. This was a time of sharp increases in G as well. # So can G be relied upon to avert recessions? Looking at Table 1.1 one can see that Gross Domestic Private Investment fluctuated the most during recessions, when business activity was assumed to decrease and businesses waited for the Federal Reserves to offer the lowest borrowing rates for investment. In comparison, C didn't fall much and nor did G, which actually rose steadily, as though to make sure Y rose in spite of other reductions. So it would seem that Recessions might be avertable with G, for if not, how did FDR's Public Works programs work in the 40s? Recession are but a small aberration from the 3% growth rate in Y or GDP that the economy is set to grow at, after all. To answer this one needs to understand how G is spent and why perhaps, G may not completely rise to make sure GDP rises at 3%. # What does GDP look like? To see how the US Government Taxes and Spending has looked like between 1929-2002 see Table 3.1. Government Current Receipts and Expenditures (Annual 1929-2002), -- http://www.bea.doc.gov . It's from the Bureau of Economic Analysis, a part of the US Department of Commerce. # How was the Money raised? Table 3.1 shows how Taxes grew from $10.6 billion in 1929 to $2872 billion in 2002. It also shows how Current Expenditure was approximately equal to Taxes up until 1942-1946, WWII years. This period also signifies a sharp rise in Business Taxes, something Keynes would not have liked, and it was a trend that would never subside. It also shows that Indirect Business Taxes accounted for a large portion of tax receipts in 1929, a trend that still exists. # How does the Government Spend your money? Table 3.1 shows that: Consumption Expenditure accounted for a major part of Current Expenditure in the 30's, 40's and 50s though this ratio fell as more and more money was distributed as Transfer Payments, primarily to Individuals. Transfer Payments to Individuals rose dramatically since the 1946, accounting for 20% of Current Expenditure compared to 1/16 in 1945, probably due to more unemployment after the end of WWII. In the 60s, Transfer Payments to Individuals fell, probably due to higher employment statistics. The 70s marked a sharp increase, transfers again becoming almost 1/3rd of all payments, and in the 80s and 90s the ratio is more or less the same. Foreign Aid is just $14 billion out of $3126 billion in 2002, showing a complete disinterest in spending money on international programs for development, a trend that is not very different throughout the Century. Interest Payments on Government Debts to Individuals and Businesses in the US went from $10 billion to $314 billion in 2002 -- average of 10% of Current Expenditure, and ranging from 7.5% in 1968 to 14% in 2002. In comparison, Interest Payment to Foreigners also started at $0.3 billion in 1960, rose sharply in the 80s to $12.7 billion, and is now $73 billion. Prior to 1960, interest paid to persons and business (line 13) and interest received by government (line 15) are not shown separately, but are included in net interest paid (line 11). # What does Consumption Expenditure look like? See Table 3.7. Government Consumption Expenditures and Gross Investment by Type (Annual 1929-2002) Consumption Expenditure = Federal Expenditure + State and Local Expenditure In 1929, Federal Government Expenditure was small compared to the State and Local Government Expenditure -- a 1:4 ratio. In 1941 the trend had reversed, making Federal Budgets twice as large as State and Local budgets. A year later the Federal Expenditure was six times as large, and the next year, ten times. The 50s showed a cut back in Federal Expenditure to $20 billion from the war-time high of $97 billion in 1944. Thus, the Federal budget returned to being twice as large as State and Local combined. Around the late 50s a sharp rise occurred in State and Local Funding, making it at par with Federal. This trend never reversed. State and Local Spending ($1,279 billion) is now twice as large as Federal Spending ($693 billion). # What is Federal Spending and Investment (Inventory = Investment)? See Table 3.7. Federal Spending and Investment = Defense Spending + Non-defense Spending In 1929 National Defense and Non-Defense Spending were almost equal at $0.9 billion. The 30's saw a sharp rise in Non-Defense with Roosevelt's New Deal Economy, while outside Federal Spending State and Local Spending remained constant at $9 billion. In 1941, this trend reversed and Defense Spending outpaced Non-Defense at 4:1, and in 1942 the ratio was up at 17:1. In 1943 it was 40:1, and in 1946 it was back to peacetime levels of 6:1. This trend changed, as Non-Defense started picking up in the 60s and until '67, when Defense Spending again rose sharply. The Defense budget in 1980 was double that in 1970, and in 1990 it was double of 1980s. In the '90s, Defense Spending stayed constant around $360 billion, but Non-Defense Spending rose sharply since 1989, doubling in 2002. # The nature of Defense Spending & Raising G to fight off 21st Century Recessions Looking at Table 3.8. Real Government Consumption Expenditures and Gross Investment by Type (Annual 1987-2002) http://www.bea.doc.gov, one finds that: While Defense Spending has fluctuated, Non-defense Spending has only risen steadily -- as have State and Local Spending. Looking here it may seem that Defense Spending is the part of the budget Clinton and Congress found most easily changeable and thus did, while other programs saw a rise. It would seem that if any part of G were to be used to raise employment in the short run it could well be by raising Defense Spending. Other programs looks a lot less flexible, though increases might be appealing. Also revealing is that people already pay a huge sum of money on Taxes -- $2872 billion in 2002 alone, and thatt Payment of Interest to Americans and to Foreigners accounts for a huge percent of Current Expenditure -- almost $400 billion in 2002 alone -- thus implying a huge tax burden on current tax-payers for interest in National Debt alone. This is equal to the National Defense Budget in 2002. Can G be raised any more? # Raising G to fight the modern day recession? We just established that the tax and national debt interest payment burden on the US is enormous. Asking for more money, whether via borrowing or taxes, seems embarrassing. In fact, the debate now is the opposite of what FDR was facing, that perhaps G is too large and to keep it large the economy is really testing the limits with Gross Domestic Private Investment, as one might say about Greenspan's declaration of inflation, recession and the consequent business slump in the US. Also, looking at statistics found in Table 1.1, it seems that GDP growth has not fallen, but in fact remained the same -- 3% between 2000-2002. It would appear that we don't even have a recession, in technical terms. It's true, GDP growth for 2001 was lower than 3%, but a rise in GDP growth in 2002 made up for it. Why then are we calling it a recession? If you follow statistics of Reagan-Bush Sr. years in the '80s this is revealed. They liked to borrow money and they believed in Wartime Defense Spending. (Is that why we call it the Cold War?) The current Bush Administration is doing the same. Bush Jr. is further using the concept of a recession to reduce interest rates, such that Gross Domestic Private Investment goes down as in recession time and the dependable "Government Spending" is used to bail the economy out. In fact, this rise does result in GDP growth going up in 2002 from 2001 levels. You could get the Congress to increase the Defense Budget this way. And you sure could get your Wartime Defense Spending back. I believe Republicans of the Reagan-Bush camp believe in the power of Wartime Budgets and will use it to show that GDP has gone up. They also like to keep interest rates down so that the business community can borrow at less -- provided business loan rates are flexible. Clinton surely benefited from the low interest rates available to businesses before his election in '92. So, he was able to enjoy healthy Gross Domestic Investment and could cut back on G. This pattern reveals one thing. That politicians are not very hard-working. That they always take the easy road to "short-term success". That they do not know how else to use G to save the economy. |
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