Economics for Politicians Chapter 3: Introduction to Macroeconomics – So that’s how government spending fits in! [Reader Post]

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Cross posted at Brother Bob’s Blog

Welcome back, humble politician! Now that you understand the basics of how economics work on an individual (microeconomic) level, in this lesson you will learn how all of these choices roll up on a national level, or Macroeconomics. In the second economics class that you probably slept through during your pre-law school days the concept of GDP, or Gross Domestic Product was introduced. Put simply, GDP is the sum of all economic activity. You’ve no doubt seen a chart showing GDP growth before that looks something like this:

So what do all of these joined points represent? They are an aggregate (sum) of all of our measurable economic activity, made up of a few broad components that give you a formula that looks something like this:

Y = C + I + G + (X-M)

Y = GDP

C = Consumption. As the name implies, this is made up of anything that we consume, whether it is for food, clothing, entertainment, housing, etc.

I = Investment. Put simply, this is our collective savings. We invest (or as some of you like to refer to investment by private citizens, “speculate”) our money based on our goals for safety or higher returns. People who prefer safety will invest in stable, low return investments, such as Certificates of Deposit (CD’s). People who want a higher return will invest in riskier vehicles that expect higher returns, such as small cap stocks, starting their own business, or investment grade junk, such as bonds issued by the state of California.

G = Government Spending. This is of course your favorite piece of the economy! This represents everything that the government spends, whether it is on entitlements, military, infrastructure, (government) employee salaries and benefits, or payback for whatever interest groups helped to elect you.

X-M = eXports – Imports. Most macroeconomic models lump these two together, as they show how you add to the GDP all that we export for sale, and reduce it by how much we import from foreign countries. For our purposes I am going to use the algebraic methodology to back this out by subtracting them from both sides of the equation. This is too complex to go into great detail, but even though our import dollars go overseas, that item imported goes toward our own consumption. And likewise any item that we sell overseas that invests in America is actually consumed by someone outside of our GDP. There is a lot more to this, but Production Possibilities Curves and Comparative Advantage are concepts that are too advanced for you at this stage. But stick around – hopefully by the end of these lessons you will be ready to learn them too!

Back to our equation, if we back out the offsetting effects of imports and exports we get a simpler formula:

Y = C + I + G

To describe our overall economy in layman’s terms, think of your own household’s economy and look at your own paycheck. Before your direct deposit hits you see various federal, state, social security taxes, etc. taken out. Then of course you have to pay your property taxes, registration fees for your car, taxes on your investments, plus all of the other not quite as visible taxes, such as sales taxes and the higher prices you and your bretheren force everyone to pay as a result of regulations and trade barriers. This is the equivalent of the “G” portion of GDP.

Now that we’re past the portion of your income that you have to spend or face jail time, the next part is your household consumption. As I mentioned earlier this includes anything you’re spending to, well, consume right now. This is your food, clothing, whiskey, your car, your housing (although if you have a mortgage this could be more appropriately under investment or split between the two categories), going to the movies, books, vacations, etc.

What you have left is what you save or, invest. I’ve already listed some possible savings vehicles earlier and won’t recap them, but it is critical that you understand the distinction between government spending and investment. Contrary to what politicians holding the purse strings like to say, government spending is not a form of investment. An investment involves a choice being willingly made by an individual or organization looking to gain a return on the money that they are risking. Forcing tax payers to sink money into high speed rail lines that will go unused or wind mills that will produce expensive, inefficient energy are not examples of investment. There’s a reason that Joe Biden doesn’t invest his own money into rail lines. There’s a reason Al Gore doesn’t just invest his own money in green energy rather than bray for subsidies and regulatory mandates. It’s the same reason you don’t, and the same reason the rest of us don’t. These items have a proven track record of being bad investments, so please don’t tell us what a wonderful job you’re doing of managing our money when all that you’re really doing is doling out favors to the unions, green groups and various other members of the powerful anti-prosperity lobby that helped to get you elected.

Now that you see how government spending fits in and you remember where your money comes from, you can start to see the big picture. Any time we increase the G part of the equation, less is left for C and I. Even if you don’t take it away from us today, the American people are not as stupid as you think we are. We know that the money you borrow will eventually have to be paid back in future tax increases (or “revenue enhancements” as you like to call them) or through inflation, which will hurt the return on our investments and savings. Now you can start to see why the various government “stimulus” programs wound up having little effect and if anything, slowed our economy. Actually, this is a good point to break for today so we can resume with…

Chapter 4: You don’t create jobs – It’s time to get over FDR!

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Brother Bob, excellent, simple, and to the point.

We have some on here who wish to claim that in the current state of the economy, that cutting government spending will have a big negative impact on it, and ultimately, the GDP. Then, in nearly the same breath, they will want government to increase taxes and make assumptions that that will not have a negative impact on the economy, and ultimately, the GDP.

It would seem to me that if taxes were raised, money is taken from the C (consumption) variable, but wouldn’t necessarily be added to the G (government spending) variable as government spending would remain nearly the same whether taxes are raised or not. So, what do we end up with, then? A lower GDP due to a lower amount of consumption. We are not quite into an economic growth period where talk about raising taxes makes sense at this point.

At the risk of public pedantry, I would note that “G” does not include transfer payments. The assumption is that transfer payments are spent by the recipients, and thus appear in “C”.

Thanks Bob, I was working on a similar remedial economics synopsis for the fiscaly dysfunctional within our executive branch earlier today, but you did an excellent job of explaining the basics to the economic illiterate. Hopefully the crew in the WH will read it. Obama and Geitner could turn the course of history if they could only grasp these concepts, but I realize you can only ask so much from a Community Organizer.

Keep writing.

Contrary to what politicians holding the purse strings like to say, government spending is not a form of investment. An investment involves a choice being willingly made by an individual or organization looking to gain a return on the money that they are risking. Forcing tax payers to sink money into high speed rail lines that will go unused or wind mills that will produce expensive, inefficient energy are not examples of investment. There’s a reason that Joe Biden doesn’t invest his own money into rail lines.

Here’s what’s wrong with the above statement.

A railroad company will only build a rail line if it can make money off the rail line. The government built the Interstate highway system to “promote the general welfare” (a phrase mentioned twice in the US Constitution). If the Interstate highway system had been left to private investors and financed with tolls, vast segments of it would never have been built. The existence of the Interstate Highway system has had a huge economic benefit (think commercial trucking; think commuting; think vacationing) which would never return to the private owners of the highway in question, but which clearly promotes the general welfare of the country at large.

Private industry seldom invests in the basic research which generates new paradigms and new industries. Government sponsorship of basic research also promotes the general welfare.

There are numerous additional examples.

– Larry Weisenthal/Huntington Beach, CA

Hola gang! Sorry for not responding sooner but I’m jut getting back into the swing of things after a business trip. I submitted this to Curt during breakfast as I was getting ready for my flight out…

@MG – Neat article summarizing our issues. I’m a bit surprised we’re not hearing more Hugo Chavez comparisons yet.

: Your comments are a good preview for where my next few posts are going – unintended and intended consequences of the government

@Ameryx: Actually, yours is a very good question. For our purposes we’re not looking at the velocity of money. When you get down to it if you follow any government spending to its extension anything in G can ultimately become part of C or I. On the other hand, everything in G has to come from somewhere, namely by reducing C or I. I’ll be dropping some Bastiat in the next post.

@Skook : Thanks for the props. I love your writing style (which I plan to rip off in a future post comparing our foreign policy to a Metallica mosh pit) & coming from you that means a lot.

@ Larry: Excellent counter point. On a non-economic historic note the highway system was built for the purpose of national defense to be used as interim airfields in the event of invasion. And yes, I realize I just further argued your point. =8^)
While the highways probably would not have been built in the exact same spots, why do you assume no highways would not have been built by private companies who would charge tolls to cover their expense and the maintaining of the highways? Not many would argue that had the US govt. not built it that someone else would have found a toll road connecting the east and west coasts to be a profitable venture. Our cities might not have grown as they have today but why would they have not developed differently if private companies had built our highway system?
To throw your argument back at you about railways, you are correct that a company only builds the line if it is profitable. If it is not it gets shut down. Whereas if the government builds a railway that is unprofitable the company throws money at Joe Biden and the rest of us are forced to subsidize it – Amtrak. That would be exhibit A for private sector functioning better than the public.

Everybody, next post on this subject will be some time next week. I’m wrapping up a massive post I had started a while back, let fall away between the move & the wedding, and recent events pushed me to finish – how the left still doesn’t understand the Tea Party as told through the five stages of death and dying. Thanks for reading and thanks for the comments!

@Brother Bob: @openid.aol.com/runnswim:

Actually, guys, it could easily be argued that the national highway system has somewhat solid roots within our Constitution.

Article I, Section 8;

To establish Post Offices and Post Roads;

Where Post Roads is defined as;

Post road
post road n a road over which mail is carried

It could also just as easily be argued that the Interstate Highway system was brought about in part due to National Defense concerns. Did you know, for example, that in 1919 a convoy of army trucks was sent across country to test the efficiency of the roadway system? And did you also know that it took that convoy 62 days to cross the country?

Now, while everyone, or most everyone, attributes the formation of the Interstate Highway system, it’s roots can actually be traced back to 1941, when FDR formed a committee to evaluate the need for a national highway system.

Just a few points to consider about the Interstate Highway System.