The other other shoe to drop: big government in-the-loop?

This depression is historic in many ways, but one way that doesn’t get talked about a lot is that it’s the first time America has had a credit-based downturn with a government that is a major existing factor in the economy. Before the Great Depression, in the 1920s, government spending at all levels was around 15% of personal income. Today, it’s close to 50%. Sure, government spending shot up under FDR, but the point is it shot up from virtually nothing. What happens when you hit a depression when government spending is already over one third of GDP before the depression?

Tax receipts projection
Tax receipts projections.

So, we have this situation where there is a huge economic entity that is about to see its income drop precipitously, as tax revenues fall off a cliff. Whether by spending cuts or inflationary printing, future real government contributions to the economy are going to have to decline. It’s easy to forget, but the government doesn’t actually make anything. Whatever money they spend either comes from the present or the future or from inflating the currency, but either way it is a hole that has to be filled sometime. Due to the large delay between the effects of a downturn and government spending, this will take a while to play out, and it’s a huge overhanging issue that has yet to completely hit the proverbial fan.

Here’s the thing that scares me about all of this: one of the tenets of control theory is that having a strong feedback loop with a large delay in any system is a good recipe for instability, and yet that’s exactly what we have when the government becomes such a large factor in the economy. Of course, an economy is not a model system, and it could never experience runaway instability like a linear circuit could. But if there are forces pushing it towards instability, I’d argue the result may not be exponentially growing oscillations, but it won’t be good. Humans don’t like unstable systems, especially when their money is involved, and rather than suffer oscillations, I suspect the economy would just fall and stay down.

Why hasn’t this happened before? Well, one likely possibility is that I’m completely out of my mind to be applying principles of control theory to the national economy. But another is that we’ve simply never tied this big of a feedback loop around our economy before. The last time we had a credit dislocation, perhaps government was small enough that these oscillations were damped. But the gain is way up, now, and I’m a little nervous to see what happens now that the system has been given a big kick.

21 responses to “The other other shoe to drop: big government in-the-loop?”

  1. I am not sure what you mean when you say the government does not make anything. It is largely a service based organization, but it does spend huge amounts of money having things made for it by contractors: Buildings, Military Bases, Vehicles, Weapons, Dams, Ships, Office Supplies… and so on, in fact it is hard to think of something that the government does not buy.
    If you mean they are not manufacturers for resale, then that is mostly true, but I don’t understand what the significance is.

    The worry about tax revenues falling off a cliff is valid, but I thought the whole point of the stimulus spending is that it would put unemployed people in jobs and companies to work, and both of those activities generate tax revenue as well as having a domino effect from those people and companies spending their paychecks on other stuff from other companies…

    There is a certain amount of risk in the stimulus strategy, but I think of it like a person in an out of control car racing towards a cliff. You can stay in the car and hope that the seatbelt and airbag allow you to survive, or you can open the door and leap out, possibly breaking a leg. Both options have substantial risk, but the “stay the course” option seems even worse.

    • Thanks for writing, Michael. What I meant about the government not making anything is that they do not create wealth, only redirect it. So, the stimulus money will come from somewhere, in this case it will come at the expense of future spending and increased taxes. This future “shock” will be large and extended in time. The economy is a physical system, albeit a very complicated one, and when you put large feedback loops with long delays on physical systems like that, weird things can happen. And that’s not even touching upon the question of whether or not we’ve reached the limit of how much debt to government can get into. Remember, before the great depression we didn’t have government debt totalling nearly an entire year’s GDP.

      Also, people debate whether or not government created jobs are really helpful to a recovery in the long run. For example, if your construction job is related to a stimulus bill, how secure are you going to feel? The historical record is not clear as to whether Keynesian stimulus has ever worked, except in WWII. Also, instead of the market deciding where works needs to occur, and allocating capital efficiently, you have the dishonest clowns in congress like Pelosi deciding where. So much of the stimulus package is just useless pork.

      You can make all the analogies you want, but nothing really substitutes for actually thinking about the problem. I might as well say that the stimulus package is like further depressing the accelerator pedal in a car racing towards a cliff. Does that help my argument at all, though?

      • So by your reasoning, there is nothing the govt can do to stimulate the economy?
        It seems pretty clear to me that if the government hires 100 people to do something productive that has lasting value like build a bridge or road or school the physical product is the first level of payback. When the workers that worked on these projects spend their paychecks for clothes and cars and services that is a second level of payback (not to mention that they are not unproductively collecting unemployment benefits). When society gains capabilities from being able to use those roads, bridges and schools, that adds value to the areas where these amenities exist, which increases real estate values, which is another level of payback. These are just the direct benefits. The dominoes spread out from each of these effects. Like the businesses supplying materials for the Buildings/roads, and the lunchwagon supplying food a the construction site, and the gas station selling gas to all the workers going to their jobs and so on.

        The idea that the market is somehow smarter than individual people is quite mysterious to me. It seems to me that the market reflects the values of the society that it is in, so in a society where there is little long term planning and willingness to do anything for quick profits that is what kind of market you have. And that was the kind of market that gave us our current economic mess.

        • I’m not saying the government can’t stimulate the economy, just suggesting there are limits to it. Otherwise, why don’t we just have the government spend a trillion a month and live like kings? I’m worried that given that the feds are already on the hook for north of 12 trillion, we may be hitting that limit.

          I’m not even really getting into the debate as to whether or not Keynesian stimulus works to begin with. I’m still undecided on that. I think people get too polemic about it, and I suspect there are indeed times when it works.

          But to your points: do you know how much of the stimulus bill is actually going to infrastructure? I think it’s less than 1/6th. The problem with the government deciding where money goes is that the government is full of some of the dumbest, most dishonest people you’ll ever hope to find. It’s hard to believe how much this is the case, because it’s such an unpalatable thought. But what else can you say about people who can’t be bothered to read a $800B spending bill because waiting two days is too long, but yet who had no problem taking their winter break in the middle of a financial crisis?

          I appreciate your point that the market will somewhat reflect the quality of individuals who make it up. I think there’s truth in that, but the market also has mechanisms to punish those that screw up, hopefully taking away their ability to make further mistakes than affect us all. If left alone, the market will reward good behavior and punish bad, weeding out the incompetent. Provided, of course, we operate markets with integrity, which we haven’t. But that’s a criticism of our ethics, not the idea of capitalism. People keep using anarchy as a false strawman for capitalism, which is unfair.

          If people in a free market are too short sighted, they will eventually be beaten by people who are long sighted, no? Capitalism doesn’t say everybody wins and life is perfect. It just says those who make poor choices should pay for them. Why not be short sighted when you know the government will bail you out when you screw up?

          The markets did NOT cause this. It is government intervention in markets that caused this! Do you think if the markets were allowed to operate freely, we’d really have situations where mortgages on $700k homes were given to strawberry pickers? It was government backing of mortgages, incentives on banks to lend, and the risk-taking engendered by prior bailouts that let this all happen. And most of all, it was Fannie and Freddie taking on everybody’s junk, which could ONLY have happened with the implicit backing of the government. No truly free market in the world would’ve allowed this to happen!

          We’ve gotten more and more socialist, with the government intruding on everything thanks to clueless do-gooder legislators who think everybody has a god-given right to own a home, and when we finally fuck it all up, now all of a sudden the fools like Barney Frank who made a career out of screwing with markets say “look what the markets did!” We haven’t had free markets in this country for a long time. Don’t be fooled by the rhetoric coming out of either party.

          • This will be my last post on the subject, unless you want to talk about publishing this as a book.
            My understanding of whole concept behind free markets is that it is the most efficient way to run an economy because you can always count on people to look after their own self interest. In a way you could call it economic Darwinism, in that the business with the best practices wins over others with less good practices because they will be more efficient.

            This sounds great in theory, but there is a problem. In the history of the world, there must have been at least one tribe/state/country that tried a totally pure free market, and this entity would naturally have prospered because it had the best economic system of all the other entities around it. These neighbors seeing the great prosperity and efficiency next door would naturally clamor for that policy to be implemented in their town, and so it would. This process would repeat over and over again, because competing systems could not compare in simplicity and efficiency, and soon the whole world would be converted. By now you see the problem, this never happened. Not because free markets were not given a chance, but because they do not work. There are a million arguments why they do not work, but I think the simplest one is that people with power (because of their inclination towards self interest) look for ways to increase that power, and that means using whatever means they can to influence their environment to favor them over others. In other words they look for ways to game the system and in true Darwinian fashion the ones that do it best get the most goodies, and all the others watch what the most successful ones have done and copy them and then try and take it one step further, and further, until the public decides enough is enough and elects someone that will stop the chaos.

  2. Michael,

    When did I, or anybody else, say free markets were impervious to degenerating in the face of outside influences? I just suggested it was a good idea. I’m aware of how fragile it is, believe me. What system isn’t capable of being gamed and abused? Hopefully, we will evolve towards capitalism with some integrity, where we operate free markets constrained by well-considered rules, not the whim of populist senators.

    And I don’t think “we’ve tried everything.” Human civilization really hasn’t been around all that long. I don’t think free market capitalism was really possible without modern economic thought, so I’m not sure why anybody would’ve tried it before.

    I don’t want to be an ideologue, on the other hand. I don’t have blind faith in capitalism, and think it must be tempered with ethics and low tolerance for deceit and coercion. I also don’t think it works in all cultures. People need to be educated and capable of at least a modicum of ability to think of consequences. Capitalism isn’t a sufficient condition for success, but I think it may be necessary.

    Anyway, I understand if you’re done with the argument. It is getting long. I appreciate the debate, though.

  3. Hi Jonathan,

    I think this is the crux of your misunderstanding with Michael:

    “The idea that the market is somehow smarter than individual people is quite mysterious to me.”

    Maybe you pointed this out, but individual people ARE the markets. They are the economic actors that make decisions about how to spend their money by entering into voluntary transactions with other actors.

    By ‘individual people’, does Michael mean the decision makers in government? If so, I would refer him to Friedrich Hayek who observed that a country’s economic system is far too complex to be regulated by a small group. Better to let people be free to enter into economic transactions of their own choosing. If I go to your house and say, ‘Hey, I like your flat screen TV. I’ll give you $10 for it,’ you’re going to tell me to take a hike. If I say, ‘I’ll give you $5,000 for it,’ you’d probably say ‘Sold!’ And we would hopefully both walk away thinking we got a good deal. (At least until my next visit to Best Buy.)

    Here’s where I think you are hitting on something:

    ‘The markets did NOT cause this. It is government intervention in markets that caused this!’

    Here is what I wrote to my Dad and my sister (who for reasons that aren’t clear to me proclaims herself a socialist) just the other day:

    People in any industry are playing a game called ‘Commerce’. To win ‘Commerce’ you have to make money. In some leagues, Commerce is a very simple game, but in others, there are lots more rules. An entity, let’s call them ‘Congress’, writes the rules. In order to win the game, it is in the players’ interest to learn the game as best they can and use the rules to their advantage. Every once in a while Congress changes the rules of Commerce and the players have to spend time and money learning these new rules and then they have to re-write their playbooks to maximize the amount of money they make playing Commerce. And some times those rule changes are a good things. Other times, they really screw up the game.

    I think this is the most undiscussed aspect of this crisis (BTW do you really think it’s a depression?). It’s one of the reasons I want to smash Barney Frank (BARNEY FRANK fer chrissakes!!!) in his fat smug face when he has the nerve to lecture Bernanke, Geithner, Liddy, et. al.

    Also, you’re so right about the stimulus package not being stimulative. It’s one thing to argue about Keynesianism (I happen to think it doesn’t work) but this isn’t even Keynesianism. Yes, there are some stimulative effects, but they are fleeting (can you believe that Obama actually used that same adjective to refer to the 25-year boom of the Reagan/Bush/Clinton years?)

    And my response to Michael’s last post was the same one I made to my sister the other day when she said she was a socialist; I paraphrased Winston Churchill: Capitalism is the worst economic system, except for all the others that have been tried. No other system provides the standard of living that a free market economy does. Is their unfairness? Absolutely! Do some people make bad decisions? Of course they do. Would I have it any other way? Not on your life.

    Also, you articulated something that I had thought about but which hadn’t coalesced into a concrete thought: the idea of the feedback loop. I think what you are saying is that, we are taking all this drastic action and we don’t yet have a clue how it is going to affect the problem. And yet everyone in government is talking about more and more drastic action. It’s like flying a plane. They are chasing dials. Most of the time, uou have to make small incremental corrections and then wait for them to take effect.

    I know I am preaching to the choir, but it’s a Jacobim Mugatu moment for me. Remember at the end of ‘Zoolander’ when he screams at the crowd, ‘What am I taking crazy pills here? Blue Steel? Magnum? It’s all ONE LOOK!’

    Great stuff!


  4. Well here I am getting dragged into this again.

    When the government spends x dollars to build a bridge it is called stimulus, and when a private individual does it is is called business.
    What is the difference between these two acts? They both have the same end product, they both use the same materials and labor, so why is there any difference in the economic consequences of the two events? I don’t think there is. Spending is stimulative.
    Where the spending money comes from can have some consequences, but since the money is being borrowed from the future and the expectation is that the economy and tax revenues will grow the big questions are how much it will grow and how fast.

    Here is an example from my own life. Our condo building needs a new roof ($50k) so we need to take out a loan from the bank to pay the roofer, but the bank (F@#king BOA) does not want to lend the money (in spite of our credit being fine). So the roof does not get fixed, damaging the building (decreasing it’s value), and the roofer does not get paid, so he has to cut his workers or go belly up. Of course the roofing material supplier is going to be hurt (Our condo’s situation is not unique) and the material manufacturers will take a hit. Say a year from now the economy miraculously bounces back without any stimulus effects and the bank will now be willing to lend the money. At this point the roofer’s workforce has dispersed looking for work, and he has sold his equipment, and the roofing supplier is also gone. Complex systems are hard to restart once they have been dismantled.

    Now imagine that instead of the roofing company disbanding they are hired by the government through the stimulus package to redo the roof on local schools, and instead of the roofers disbanding and going on unemployment, the complex system is preserved and when the economy bounces back (and the bank is finally lending again) they are ready and able to fix my roof. Even better yet would be the government either subsidizing or guaranteeing loans (to make it attractive to banks) so I don’t have to wait a year (causing more damage to my building), and I can get the roofers to work tomorrow.

  5. Michael,

    There is a very fundamental difference between these two acts. When a private individual uses his own money for business he is engaging in a voluntary action and so it is in his interest to make the best use of his money.

    When the government does it, it is an involuntary transaction. To build that bridge, they have to take yours and my money and put it to a use with which you or I might not agree.

    And since the government, in the form of the agency that tenders the contract and the contracting agent, isn’t using its own money. So they don’t care if the money is spent particularly wisely or effectively. Government is wasteful because the people spending the money don’t care as much about getting a good return on the investment.

    I subscribe to Friedrich Hayek’s axiom that modern economies are far too complex to be run by an individual or group of individuals. It’s far better to give people as much liberty as possible so that they can enter into transactions voluntarily.

    Also, I think that you still haven’t addressed on of the main objections to the stimulus package. Namely that much of it is not stimulative in the slightest; much of it is pork. Much of the spending will likely take place after the economy has recovered or begun to recover.

    I think your example is somewhat flawed since even if the roofer has gone out of business, won’t there be other roofers willing to do the job?


  6. I guess I should have been clearer. I meant that economically that there was no difference. Whether it is in the individuals perceived best interest is moot, as a few months ago huge numbers of people perceived that investing in real estate was a great idea. Foolishness is not confined to the public or private sector.

    Pork is an extremely exciting and useless term.
    The only activity that I can imagine that would not be stimulative is perhaps burning or burying the cash. Everything else seems to involve buying services or products which need to be supplied by someone. We can argue about the relative efficiency of the stimulative effects of different spending strategies but I suspect that individuals who are not targeted at stimulating the economy are no better at it than the government which is at least partially focused on it, as their reelection to a large extent depends on the success of the stimulus.

    Sure there will be some roofers left, but they will be overwhelmed by the backlog, and consequently will raise their prices through the roof and they will probably do a barely acceptable job as they will have virtually no competition and a huge volume of desperate customers. Hardly a better solution the preserving the more optimal current situation (roofer/customer ratio).

    BTW in reading your responses it seems as if you are not actually reading my entire posts as you are ignoring about 2/3rds of them.

  7. Michael,

    Yes. I am reading your posts. I am not ignoring them. It’s just that I don’t agree with them.

    The bottom line for me is that I feel it would be far better for the government to leave the money they plan to spend in the pockets of the people and allow them to choose how to spend it. Wouldn’t that provide the same stimulative effect as the government spending the money? I don’t trust the government to do much of anything well. And I think the government has inserted itself into a lot of arenas where it doesn’t belong.


    • Well now we are getting to the crux of the matter.
      This has nothing to do with economics, but is all about trusting the government.
      I suspect that you do trust the government to do some things, unless you grow all your own food and make no use of any (untrustworthy) public services or facilities.

      If I got a $100k check from the government tomorrow I would probably pay off my mortgage and my credit cards and then put the rest into gold. That would be a very wise safe investment for me, but given how banks are being so stingy about giving loans (in spite of the cash have been pumped into them) I think the stimulative effects of my choice would probably be less than almost any government public works project.

      The fact is that everyone I know has the impulse to spend less until this mess bottoms out, but the thing that is keeping it from bottoming out is people spending less. The government’s job is to take the longer view, and even if they do it imperfectly, it is better than the short, self centered view that individuals have in this current circumstance.

  8. Also, I don’t think ‘pork’ is a useless term at all. Why should taxpayers in Virginia and Idaho pay for a peace garden in North Dakota, or tennis courts in Florida, or basketball courts in South Carolina? If people in those states want those things, they should pay for them themselves.

    You’re right. It can be stimulative, but I am not objecting to it on those grounds.


    • By that reasoning why should there be any cooperative ventures like national defense or public roads? After all, if I live in Ohio, why should I care if the rest of the country sinks into the sea?

      Personally I think having 1000+ military bases all over the world is not a good idea, but I do think that having some national defense capability is a good idea so I accept some things I don’t like to get the things I do want. The alternative is to live on a boat in the middle of the ocean and then I can have everything exactly they way I want it.

      A big part of becoming an adult is getting over the paranoid 6th grade Ayn Rand fantasy that we are better off alone, and realizing that the reason the human race has survived is our ability and willingness to cooperate and help those who need help, because we will need help someday.

      • Michael:

        Seriously, give me a break. You’re making ideological straw man arguments. Nobody said the national defense wasn’t a worthy cooperative goal, and nobody said there is no role for government. I’ll admit the Right gets a bit too small minded about certain things, and accuses anything they don’t like of being socialism. For your part, it would be nice if you’d acknowledge that there is some truth to both sides of this.

        There is a big difference between an interstate highway, and a hog farming museum in a small town. That latter is what we consider as pork. There is a continuum of degrees to which a project will benefit the common good, and if you can’t see that, this discussion is kind of hopeless. Accusing people who disagree with you of having a childish fantasy is an incredibly arrogant ad hominem to level at somebody.

        I agree that the human race only survives to the extent we cooperate, but you need to have some actual intelligent standards for what constitutes cooperation. Blind spending isn’t cooperation. Anybody with much intellectual integrity recognizes that both Republican and Democrat politicians (not voters) have not been acting in a way that is beneficial to the national welfare.

        • I guess I don’t see it as that black and white.

          I agree there are some less stimulative ways to spend money and there are better ones too. I believe that stimulus does work and so I am willing to put up with a few hog farm museums to get the much more numerous federal building energy efficiency upgrades or bridge repairs.

          Of course if you don’t think any of those have stimulus value then all of it is objectionable, but I don’t see it that way.

  9. As for the roofers dilemma, seeing the rise in prices for providing roofing services, won’t other workers decide to enter the trade thereby reintroducing some of the lost competition?


    • Yes, other workers with no experience or commitment to the roofing industry, but as there is a huge amount of desperate people with leaking roofs they can afford to rip people off right and left. By the time the word gets around they are bad news they have left town or changed their name. Since the number of reputable roofers with a track record has decreased by the die off there is no way to determine the value of the newcomers.

      Thinking that letting established businesses die has no consequences is like letting a house burn to the ground because it can be rebuilt. Yes it can be rebuilt, but it is not the same house with the same contents.

        • I think you can depend on pretty much all people to put their individual survival first. Where there is an opportunity to make a lot of money in a shady way the very small proportion of the general population who are willing to victimize others to enrich themselves will be attracted to that opportunity.

          I don’t claim everyone is a sleazebag, just that there are enough of them to create a messy problem.

  10. If you think government involvement in our economy can help our situation, you are seriously mistaken. They are the problem, not the soution. The problem is that the government hinders the free market by penalizing small businesses with ridiculous regulation and other forms of control while they offer loopholes and monopolies to the mega corporations.

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