Wednesday, September 23, 2009

Y = C + I + G

Are there any Keynesians out there?

The equation in the title of this post is the classical description of spending for a given country. The equation describes how Total Spending (Gross Domestic Product) is made up of Consumption, Investment, and Government spending.

For those of you who are economists, please excuse the absence of the Balance of Payments component. I want to keep this simple.

Furthermore, I am going to ignore Investment. Converting money into goods and services is important, but like Imports and Exports, it is not going to help this discussion.

What remains is a very simple idea: GDP is directly related to the sum of our government’s spending and the spending of individuals. Why is this important? Because these two sources of spending COMPETE with one another.

Our country is embracing the idea that more government spending is what is necessary to make life better in the United States. It seems to be “the right thing to do.”

But is it, really?

I am one of those people who tend to personalize things. If I want to analyze a public policy, I look at what impact it will have on me. If I think of myself as the “C” in the equation, and our government as the “G”, an increase in government spending or an increase in my own personal consumption should lead to an increase in GDP.

But, in personalizing this, what if I am the only person in America, and the government is competing with me? Where does the “G” come from? It has to come from me, or it comes from “The Balance Sheet.”

I used to work for U S WEST, before it was taken over by Qwest. These are telecom companies, and they are regulated monopolies. They are governed by something called the Public Utilities Commission, which has jurisdiction over them setting rates and offering new services. In return for this oversight and regulation, they are given a guaranteed return on the customer base they serve.

I was impressed by the accounting at U S WEST, where budgetary numbers were always met. That may not be true today, but in the 1980s, the shareowners were rarely surprised by the financial data. If an income was expected for a given year, that was the amount of income reported. How was that possible? It was The Balance Sheet.

The Balance Sheet is what lists the assets and liabilities of a company; what it owns and what it owes. It goes up and down depending on asset valuations and company performance. That is expected. It is not of great importance to tie it to a budget.

What is NOT expected is to have income vary from budget. That is what you read about when you see reports that a company either “met expectations” or failed analysts’ expectations. Analysts are looking at income, and they judge failure in very harsh terms.

How do you move items from the income statement to The Balance Sheet? By using accrual accounting, where you categorize the income as “deferred income” or “anticipated income”. You simply classify it as something “about to show up” or “on hand but about to be spent” and put it on The Balance Sheet.

We get to see that with our government expenditures. If the money is spent, but it hasn’t shown up, it is a “deficit”. On the other hand, if the money hasn’t been spent but has shown up, The Balance Sheet shows a “surplus.”

Keep in mind that The Balance Sheet for most of us is an abstraction. We don’t care about it unless things are seriously bad. Instead, the income statement is where we focus. We want GDP to go up so that we are no longer in a recession. What do we do? We force the numbers up with government spending. Have the government spend more and GDP goes up. Life is good!

The problem with working to manipulate the numbers on the income statement is that you lose sight of the business. When your task is to make the numbers look good, your interest in the health of the economy (the state of the business) takes a back seat to the numbers.

That is what is worrying Republicans right now. Our government is doing things to make the numbers look good, and is losing sight of the country’s health. It is selecting winners and losers for the short term, and making structural changes that seem not in the best interest of America over the long term.

Of course, that depends on what each of us thinks is best for America. Not surprisingly, what we think is best for America often tends to benefit us personally.

When I personalize this issue, I find that deficit spending and/or higher taxes do not improve my personal well-being. When the government takes more from me, it lowers my consumption and that of my family.

I also have a strong suspicion that the government doesn’t spend money with the same care and efficiency that I do. I get the “double whammy” of reduced personal consumption and increased government waste.

Higher taxes slide the spending equation from me to the government. That may work for some people in the near term, but my diminished spending capacity is eventually going to make it so that I cannot give the government as much tax revenue as it needs. Here is how things are shaping up right now:

As the gap widens between what you and I spend versus what the government spends, we are going to feel a loss of opportunity and choice that has been an expected part of American culture for many years.

Republicans see a “Bad Moon Rising”. Our culture doesn’t see it at all.

UPDATE 5/22/2012:
The Facebook IPO brings up an interesting issue in tax policy.  Our government wants to figure out what to do with Eduardo Saverin.  Reichsfluchtsteuer might have worked in Germany, but is it appropriate for America?

UPDATE 7/26/2012:
Daniel Henninger, writing in The Wall Street Journal, carries the point further.  He notes that the results of the election this fall will be a mandate of the American public for either a pre-eminent public economy or a pre-eminent private economy.  That's profound!

UPDATE 8/1/2012:
Stephen Moore has a WSJ tribute to Milton Friedman.  Friedman was a monetarist; Keynes was a fiscalist.  Monetarists work to stabilize monetary policy.  Fiscalists manipulate it in an attempt to achieve governmental objectives.

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