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The key thought that underlies Obama’s recovery plan is simple. The cure for severe recession lies in trying to “grow the economy.” Spending and investment have fallen off; the government, accordingly, must take up the slack. By doing so, we’ll “get the economy going again.”

Defenders of this view assail those who contend that government spending simply crowds out private spending, exerting little or no positive effect. Precisely the problem, say Keynesian economists like J. Bradford deLong at UC Berkeley, is that private spending has not sufficed to bring back prosperity. Is not a dollar spent by the government at least as good as a dollar spent by private enterprise? At least as good — because some economists of this persuasion allege a government spending “multiplier.” A dollar spent by the government, the claim goes, generates additional spending by those who receive the money.

Economists like Ludwig von Mises and Friedrich von Hayek would challenge this argument at its central premise. In the “Austrian” view, what counts is not the level of total spending but how prices are related; in particular, the relation between prices of capital goods and consumption goods is of crucial importance. As Hayek remarks in “The ‘Paradox’ of Savings”: “In principle, therefore, any portion, however small, of the total money stream ought to be sufficient to take up the consumption goods produced with the other portions, so long as, for any reason, the demand for consumption goods does not rise suddenly in relation to the demand for means of production.” This view seems to me entirely convincing; but, unfortunately, explaining it requires a venture into fairly difficult economic theory. And an escape from this venture lies ready at hand.

The key notion in the Obama plan can be exploded in a much simpler way, one independent of Austrian theory, though entirely consistent with it.

According to the “spending” theory, government spending adds to production. It does not crowd out private spending. In a recession, there are hypothetically unemployed resources; and these can be brought into production without causing a loss elsewhere.

As suggested earlier, Austrians would object to speaking of unemployed resources while omitting price. But even on its own terms, the spending argument fails. It wrongly moves from the claim that government spending need not lessen private spending and investing to the much stronger claim that it will not do so.

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April 22, 2009

David Gordon [send him mail] is a senior fellow at the Ludwig von Mises Institute and editor of its Mises Review. He is also the author of The Essential Rothbard. See also his Books on Liberty.

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