A serious question was raised by a reader named Just Jokes. He enumerated the many advantages he saw in the gov’t hiring workers to improve our infrastructure, a win-win situation if ever there was one, he argued.
Smiling Dave has been going through JJ’s points one at a time, showing why they are deeply flawed. This time, we look at his third point, to wit:
… demand has been created where none existed for clothes, shoes, books, etc…
In other words, the old Aggregate Demand gag. Presumably insufficient demand existed for clothes, shoes, and books, and the clothing stores and shoe stores and book stores were just opening their doors to greet nobody. But once the govt pays infrastructure workers a salary, then that great wonder of the world, Demand, rises from the ashes and goes in there and buys himself some shoes and clothes and books.
I summarized this, calling it JJ’s third argument, as follows:
3. All the businesses the workers patronize have new customers [those very same workers], so they benefit, too.
Now I cannot fault JJ for thinking he has a case here. It’s what every economist known to man is saying, except for the Austrians. And we have addressed this notion many times on our humble blog, [just do a search here for aggregate demand], and we’ll do it again right now.
All economists who talk about demand agree that it has two components, desire and ability. If nobody wants hula hoops, then of course there is no demand for them, and none will be bought. So the desire for hula hoops has to be there. Now all the clothes, books and shoes JJ is talking about are things people wanted all along. The desire was there from the get go. The govt paying workers to build infrastructure did not change the desire at all. I hope that’s obvious.
The other part of demand is ability to pay for the thing. If I wake up today and strongly desire a castle, but cannot afford it, then my desire, intense though it may be, has not created any demand at all for castles. Only if I want the castle, and can also afford to pay for it, do we say I have Demand for a castle.
Now one might say that the govt paying all those workers for infrastructure has increased their ability to buy books and shoes and clothing. But that is a big mistake. Even if we grant that there is some importance to increasing demand per se in order to improve an economy [a very dubious assertion], we are not talking about the demand of one individual, or some small group of individuals. We are talking about increasing aggregate demand, meaning, the sum total of all the demands out there.
To explain this, let us consider a simple case. You have two people, Smith and Jones. Smith has $500, Jones has $5. The total demand [=purchasing power] of this little economy is, of course $505. Now let’s say Jones gets a govt job patching up infrastructure. He gets paid $200. His demand has shot up from $5 to $205. But the Aggregate Demand is still $505. And why? Because where did the $200 come from to give to Jones? Only one place, from Smith. The govt doesn’t have any money to give away, except what it takes from someone in taxes. So those $200 that Jones got was taken from Smith to give to Jones. Adding it all up, we have $300 of demand from Smith [down from $500], and $205 demand from Jones. Total is still the same, $505. Demand hasn’t increased whatsoever.
Now the truth is that the above reckoning is so obvious that even Keynes understood it [see Chapter 3 of his infamous book]. He had a subtler version of JJ’s argument, as follows:
What if Smith only wanted to spend $300 of his money, and wanted to hoard the rest under his mattress? In that case , Smith only contributes $300 to demand, because money you have no desire to spend doesn’t count. So before the infrastructure job, demand was only $300 from Smith and $5 for Jones, total $305. After we take those bucks from Smith and give it to Jones, demand has increased to $505.
There are several problems with such an analysis. First of all, what a cruel world we live in where such ideas have taken root. Poor old Smith has worked hard, saving his money to pay for his son’s college education. And we are saying, “Sorry Charlie, your son will have to remain ignorant. We are taking your money away to give to Smith.”
“But what if I want that money for my old age?”
“Too bad. Beg in the streets when you retire, because we need your money for infrastructure.”
“What if I have medical or dental bills, or my car breaks down? I’ve put aside money for that, and you are taking it all from me.”
“So you’ll be sick, toothless, and lose your job for lack of transportation. That’s not our problem. We are concerned with improving the quality of life of our citizens.”
You get the idea. If someone worked hard and earned money, he should have the right to keep it, and save it if he sees fit. that’s the first problem with Keynes’ little story.
The next problem is that reality begs to differ with Keynes’ little scenario. Nobody hoards money anymore, and they haven’t done so for about a hundred years. Instead they put it in a bank, where it gets lent and spent.
There are other arguments. A search of this humble blog will reveal them in all their majesty.
Finally. a few short words to address JJ’s final argument for the govt taxing the rich and buying infrastructure. I summarized it as follows:
The foolish rich, who don’t know what do to with their own money and just squander it away on derivative bets and speculation, are merely handing over to the wise gov’t the money that they would have lost gambling anyway.
This is of course ridiculous. First of all, the rich, not the govt, worked hard and earned the money. The rich, not the govt, have a right to do as they please with their money. Second, derivative bets and speculation are vital for the healthy functioning of a modern economy. Get a free copy of Defending the Undefendable by Walter Block and look up the chapter on speculators. Third, if we are talking about squandering away money, nobody does it better than the govt. This is so well documented, and such a part of everyday experience, that I see no need to elaborate.