Defenders of economic “stimulus” schemes insist that during a recession,government must step in to get idle resources working again. Spending on anything, anywhere will put idle resources such as labor and equipment back to work, so the theory goes.
But such crude, superstitious notions overlook (among many) an important point. As economist Steven Horwitz reminds us, capital is not homogeneous. That is, workers are trained to perform certain tasks and most machinery is designed for very specific purposes – to be performed with specific complimentary inputs.
One of the gravest sins of modern economics is its tendency to treat resources, both capital and labor, as essentially homogenous aggregates. Capital is more or less interchangeable with other capital, and labor is treated much the same. One reason for this is that such homogeneity and aggregation make mathematical modeling much more tractable, as well as making it easier to engage in econometric studies. But these assumptions can lead to major conceptual errors that matter for policy.
The problem with this is that it assumes that the idled labor and capital will be equally productive no matter where the additional spending takes place. That is, it is treating resources like lumps of clay that can be shaped into whatever form is needed to produce the goods demanded from the rise in spending. The problem is that resources are not clay. Both people and machines are more productive at some things than others, and are not productive at all at quite a number of things.
It is this mindset of indiscriminate “pump priming” that leads to government expenditures on projects such as preserving dead bug collections and administering cocaine to monkeys. But was there a glut of idle university scientific researchers amid the fallout of the housing market crash? Of course not, and thus randomly throwing money into the economy is not a harmless stimulant to economic activity.
Defenders, of course, will then argue that the stimulus spending at least gets money in the hands of those university researchers – money that they will then spend to stimulate the economy.
But let’s not forget that the government must first remove capital (through borrowing) from the economy in order to finance stimulus spending – leaving less money for entrepreneurs to productively invest in profit-seeking ventures as producers attempt to realign their production to the preferences of consumers. This process is especially damaging in light of the fact that it is investment, not consumer, spending that drives economic growth.
Spot on Brian.