Economics, Evidence and Enlightenment

Randall Hoven examines the 'theory' behind government stimulus and finds it wanting.

With today's economy, wouldn't it be nice if we knew how to make an economy grow? To know what works and what doesn't? Well, we do. We just prefer to ignore the truth.

What works is economic freedom. What doesn't work is more government.

I'm sorry that those words sound simplistic and like Republican "ideology" (or at least what used to be Republican ideology - before the Bailout Fairy arrived). But they have the benefit of being true. If you were to start from scratch, ignoring all ideology and going simply by the evidence of what produces prosperity, you would come to that conclusion: more freedom and less government lead to greater wealth and prosperity.

It's not the ideology. It's the evidence.

Unfortunately, we are ignoring the evidence and rushing headlong in the wrong direction. Alec Baldwin and others threatened to move to France when George W. Bush became President. They didn't need to. France moved here.

Exhibit A is a thorough study of what works and what doesn't, conducted over 200 years ago, by Adam Smith. He examined the economies at the time and through history and came to the following conclusion.

"Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things."

The government need not "manage" the economy, but just stay pretty much out of the way, beyond securing "life, liberty and property."

Exhibit B is the Heritage Foundation's Index of Economic Freedom. Every year the data support Adam Smith's conclusion: more economic freedom yields more prosperity, where economic freedom means secure property rights and limited government in terms of size and control of the economy.

"Previous editions of the Index have confirmed the tangible benefits of living in freer societies. Not only are the higher levels of economic freedom associated with higher per capita incomes and higher GDP growth rates, but those higher growth rates seem to create a virtuous cycle, triggering further improvements in economic freedom."

The average GDP per capita of those considered "Free" was $40,253, about 10 times greater than those considered "Mostly Unfree" ($4,359) or "Repressed" ($3,926). There is strong and undeniable statistical correlation between economic freedom (as scored by the Heritage Foundation) and GDP per capita. And it shows up year after year.

Exhibit C is the case of Presidents Reagan and Mitterrand. Reagan was President of the US from 1981 to 1989 and was considered a very right-wing, free-market zealot. Mitterrand was President of France from 1981 to 1995 and was a socialist, the first socialist president of France. This would be an apples-to-apples comparison of free-market vs. socialist governance. How did that work out?

France was behind the US in 1980 and would fall further behind it in the following years. In 1980, France's GDP per capita was 84% that of the US. By 1989 it was down to 79% and by 1995 it was 78%. (For the various international comparisons throughout this article, see the US Statistical Abstract.) In 2006, the latest year for which data is available, it was just 74%. All that wonderful socialism in France just set it back further and further from the US.

Exhibit D is Japan. Remember the Japanese miracle? From 1960 to 1991 its GDP per capita grew from 37% of the US's to 86%. It was closing in on us! By 1991 we were all afraid that the Japanese would outpace us in computer chips, high definition televisions, artificial intelligence, automobiles and overall economic growth. It would buy up all the US assets worth having and we would soon all be working for Japanese bosses.

At that point, 1991, the Japanese government spent just 31.6% of its GDP, lower than that of any European country, Canada or the US. The US was spending 37.8%. The "small government" US had an even smaller government competitor, and it was eating our lunch. Only the US, West Germany and Norway were richer than Japan at that time (GDP per capita).

But then Japan did us a great favor. It decided to grow its government. By 1996 its government was bigger than the US's as a fraction of GDP, and would remain so through 2005. In 2000 its government was bigger than that of Australia, Ireland, Luxembourg, Switzerland and the United Kingdom. It had definitely lost its "smallest government" title.

How did that work out for Japan? Its GDP per capita went from 86% that of the US to just 73% by 1995. It had fallen behind Canada, Australia, Austria, Belgium, Denmark, France, the Netherlands, Sweden and the United Kingdom by that same measure.

Exhibit E involves Japan again, but this piece of evidence is very relevant to today -- it has to do with economic stimuli. As described by Benjamin Powell at the Ludwig von Mises Institute in 2002:

"Between 1992 and 1995, Japan tried six spending programs totaling 65.5 trillion yen and cut income tax rates during 1994. In January 1998, Japan temporarily cut taxes again by 2 trillion yen. Then, in April of that year, the government unveiled a fiscal stimulus package worth more than 16.7 trillion yen, almost half of which was for public works. Again, in November 1998, another fiscal stimulus package worth 23.9 trillion yen was announced. A year later (November 1999), yet another fiscal stimulus package of 18 trillion yen was tried. Finally, in October 2000, Japan announced yet another fiscal stimulus package of 11 trillion yen. Overall during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen."

Sound familiar? Yet from 1991 to 2006 Japan's economy grew slower than that of any of the other 16 countries listed in the US Statistical Abstract for comparison - even slower than Italy's. Over those 16 years its GDP per capita grew just 16%. That of its Asian counterpart, South Korea, grew 94% in that same period. The US, Canada and most European countries grew at least twice as fast. And today Japan's government debt is 182% of its GDP, by far the highest of any developed country .

Economic stimuli work -- if what you want to grow is debt rather than real GDP.

Exhibit F is Ireland. In 1987, Ireland's government was 52% of its GDP, a higher fraction than even that of France at the time (51.9%). But by 1998 it was only 34.5% -- lower than that of the US or any other European country. It had cut income taxes across the board. Its top corporate tax rate was the lowest of all OECD countries by 2003.

How did that work for Ireland? From 1990 to 2000, its per capita real GDP grew 86%. By comparison, the US's grew just 26% in that period. France's grew just 12%. In 1980, Ireland's GDP per capita was just 61% of France's, but by 1998 it had overtaken France and by 2000 it was 118% of France's.

Exhibit G is Sweden. In 1993, Sweden took the prize for big government. It spent 71% of GDP at a time when even France was spending less than 55%. By 2007 Sweden's spending was trimmed to 51% of GDP. Still not a small government by any means, but smaller than France's, at 52%.

Over that time, 1993 to 2006, its real GDP per capita grew 42% compared to France's 24%. As its government shrank below France's, it's GDP per capita swelled above it -- from 94% of France's to 108%. Sweden cut its government burden and saw its economy take off.

Exhibit H is communism. The idea that an economy can be managed from top to bottom has been tried -- multiple times. It never worked. Not in Russia. Not in China. Not in Cambodia. Not in Cuba. Not in North Korea. Not in Zimbabwe. Not anywhere. The results were widespread poverty, famine and war. The death count due to communism likely exceeds 100 million.

Exhibit I is US history. The US grew from a British colony to the richest and most powerful country on earth. It was founded on the very principle of freedom. After slavery was ended, the US had about as close to a truly laissez-faire free market as ever existed. During that time it enjoyed about 40 years of 4% real GDP growth per year (quintupling the size of the real economy) and absorbed millions of immigrants looking for freedom and opportunity, all while expanding westward and inventing or employing new technologies from steam engines to electricity, automobiles and airplanes.

In 1913 the US Constitution was changed to allow a federal income tax and the Federal Reserve System was established. Sixteen years later came the Great Depression. President Hoover at the time did almost everything counter to free-market principles: he raised taxes, increased federal spending, restricted free trade and encouraged faulty monetary policy.

President Roosevelt did much more of mostly the same: more federal spending, more regulation, more monetary manipulation. By the end of it, Henry Morgenthau Jr., close friend of FDR, FDR's Treasury Secretary and architect of the New Deal said this:

"We have tried spending money. We are spending more than we have ever spent before and it does not work... We have never made good on our promises. I say after eight years of this Administration we have just as much unemployment as when we started. ... And an enormous debt to boot!"

Federal spending went from 3.4% of GDP in 1930 to 10.7% in 1934 -- more than a tripling of such spending in only four years -- and it would remain at those elevated levels throughout the Depression. Yet the unemployment rate went above 10% in 1930 and would stay above that level until February of 1941; it was as high as 20% as late as 1938.

Exhibits J-Z. We could go on with country after country, era after era. Whether we are talking the extremes of all countries on the planet (e.g., Australia vs. Zimbabwe) or relatively small differences (e.g., Sweden vs. France), or whether we are talking 200 years ago (e.g. Adam Smith), 100 years ago (the US vs. Europe) or the last 20 years, the evidence always leads to the same conclusion: that government is best which governs least.

There might be some point at which government is too small, where anarchy or tribal behavior might destroy such things as secure property rights, life and liberty. But with government in the developed world averaging over 40% of GDP, we are nowhere near such a point. In fact, our problem is the opposite: where the government itself becomes the thief, rather than the protector of property and individual rights.

Learning Lessons. Europe seemed to take such lessons to heart. The examples of Ireland and Sweden, above, are standouts, but not alone. From 1993 to 2007, Sweden cut its government spending by over 19% of GDP. Canada, Finland, Norway and Spain all cut theirs by at least 10%. The Euro area average cut was 6% of GDP.

How much did the US cut in that period? One half of one percent (0.5%). Portugal was the only country of the 28 listed to cut less -- 0.3%. And Japan and South Korea were the only ones to grow government in that time period, but still came in under the US in government spending as a fraction of GDP, since they started so low.

Government in the US (federal, state and local) in 2007 spent a larger fraction of GDP than did Australia, Ireland, Japan, Slovakia, South Korea and Switzerland (among 28 listed countries). In the Heritage Foundation's latest Index, the US ranks only 6^th, below Hong Kong, Singapore, Australia, Ireland and New Zealand, and its score is falling. Our score was 80.7, with Canada breathing down our neck at 80.5.

And that was before the trillion-dollar bailout Bacchanalian debacle.

In short, the US is rapidly losing its standing as the free-market, limited-government leader of the world. While Europe was shrinking its government, the US stood pat. The US is becoming just another European country -- a high-tax, welfare state with a large public sector and rigid work rules.

Unless President Obama governs counter to all his promises, campaign commercials and supporters' wishes, he will only accelerate this trend, not reverse it.

We already overtook Australia, Ireland and Switzerland by 2007. We'll soon overtake Canada, Spain, Luxembourg and the OECD average. Maybe with our trillion dollar bailouts and stimuli, we already did.

All through this time we have been lied to.

• The media called it "laissez-faire capitalism" as the government continued to eat over one third of the economy and regulated us at the equivalent of over 30 New Deals as measured by pages of the Federal Register.
• The media called President Bush a free-market extremist, while he increased federal spending from 18.4% of GDP in 2000 to 20.4% in 2006, added prescription coverage to Medicare, teamed up with Ted Kennedy to expand federal spending on education, subsidized ethanol, etc..
• The media fed the lie that out-of-control imperialism and warfare increased our defense spending to irresponsible and unsustainable levels. Yet defense spending rose from an historically low 3% of GDP in 2000 to a still-low 4% of GDP as we fought wars in both Iraq and Afghanistan, a level lower than the country experienced for over 50 years, from 1941 to 1994.

The electorate swallowed those lies and elected a man with just 11 years total experience in elective office, only 3 years at the national level, zero military experience and zero executive experience, but the most liberal voting record in the US Senate in 2007.

The conclusion I come to is a sad one: the US is no more.

At least not the US of freedom, free markets and limited government. Just when we should be reinvigorating the US brand of freedom as it had been known for generations, we are accelerating in the exactly opposite direction: salvation through government programs.

Imitating North Korea, Zimbabwe or even France is one way to get "change." Just not the change I was hoping for.

Randall Hoven can be contacted at randall.hoven@gmail.com or via his web site, kulak.worldbreak.com/.