Government Spending

Posted by PITHOCRATES - June 18th, 2012

Economics 101

Money is a Temporary Storage of Wealth used to Reduce the Search Costs in the Barter System

What came first?  Money?  Or the things we buy with money?  Here’s a hint.  Once upon a time there was no money.  Yet we still had things.  We bought things without money, you ask?  Yes.  We did.  And we bought things the only way we could before there was money.  We traded.  We bartered.  We traded things.  Things we built.  Things we grew.  Things we dug out of the ground.  Things.

These things had value.  Value we created with our labors.  Either by digging something valuable out of the ground.  Growing something of value.  Or making something useful that people valued.  And something people were willing to trade something they produced that had value.  These people created value.  They created wealth.  They were wealth creators.  And when they come together to trade the valuable products of their labors they were trading wealth.  After their bartered trade all parties in that trade walked away believing they came out ahead in that trade.  For each walked away with something they valued more.

But the barter system proved to be inefficient.  As the economy became more complex there were so many things to trade for.  And people valued some things more than they valued others.  Which sometimes made it difficult to find someone to trade with.  Search costs increased.  People spent more time looking for people to trade with than they did producing wealth.  Which is why people created money.  A temporary storage of wealth.  Using money greatly reduced search costs.  Instead of finding someone to trade with that also wanted what you had to trade all you had to do was find what you wanted.  Then trade your money for it.  Then the seller could take that money and trade it for something he wanted.  Regardless if the person was interested in anything he produced.

Ultimately People don’t want Money, they want the Things they can Trade Money For

No one likes paying taxes.  They’re one of those necessary evils to live in a civilization.  Because they are the only way to pay for public goods.  Early public goods may have consisted of a granary to store food.  And an army.  To protect your civilization from the hostile environment around it.  Government could tax the grain producers by taking a portion of their crops for the public granary.  And to feed the army.  They could tax the shoemakers and take some shoes for the army to wear.  And so on.  The government would tax the producers by taking a small percentage of what they produced to provide the public goods.   

Money changed this a little.  Instead of shipping a portion of grain from all the grain producers to the public granary the grain producers paid their taxes in money.  For it was easier to collect money from all the grain producers than it was collecting grain.  Then the government would use that tax money to purchase grain to fill the public granary.  Even having the local grain producers compete with each other to fill that large public purchase of grain at the lowest price.  Just like buyers and sellers used money to make their trades easier so did government use money to make public spending easier.  But one thing didn’t change.  Money was only a temporary storage of wealth.  The buyers and sellers created wealth.  And the government took a portion of the wealth they created.

This is a crucial point in understanding government spending.  Money isn’t what’s important.  It’s those things of value the wealth producers create that is important.  Because ultimately people don’t want money.  They want the things they can trade that money for.  Those wonderful things creative wealth producers bring to market.  Things government does NOT produce.  Even though they can print money they cannot produce these things of value.  Other people do.  Other people who incur costs.  Who pay for supplies.  And provide pay and benefits to their employees.  Which is why they don’t like paying taxes.  Because it leaves them less to spend on their business.  Or on themselves.  And they don’t like the government printing money.  Because money is a temporary storage of wealth.  And when you arbitrarily increase the amount of money in circulation for the same amount of wealth in the economy you cause inflation.  More dollars chasing the same amount of goods.  So the dollar is worth less than it was before the inflation.  And because the dollar is worth less it takes more of them to buy what they once did.  Meaning prices increase.  Which is why people don’t like inflation.

A Country never went Bankrupt by Spending too Little

So even though the government has the power to print money responsible governments don’t.  Because inflation causes a lot of economic damage.  So governments rely on taxes to fund their public goods.  But excessive taxation also causes economic damage.  By pulling wealth out of the private sector.  Leaving business owners with less.  And increasing the cost of business.  Making it difficult to hire more people.  Which lowers economic activity.  For the more people who work and earn a paycheck the more people are in the market place buying things.  So it’s important for governments not to tax too much.  Which means they shouldn’t spend too much.

Of course that’s easier said than done.  Because people tend to vote for politicians that give them free stuff.  Which is why politicians love to spend.  And to tax.  Tax and spend.  And during good economic times when government coffers are flush with cash they tend to spend more.  And tax more.  Because they can.  But they all run into the same problem.  Government raises revenue on economic activity.  By applying tax rates on income, sales, value added, property, etc.  The government collects a small percentage on these items based on the tax rate.  When income, sales, value, etc., are large that tax rate generates a lot of revenue.  When income, sales, value, etc., are low that tax rate generates a lower amount of revenue.  And when governments spend too much during the good times they raise their spending obligations.  Based on that robust economic activity.  But when the economic activity becomes less robust there is a problem.  Tax revenues fall.  Because those tax rates are taking a percentage of a smaller income, sales, value, etc.  So tax revenue falls while those spending obligations remain the same.  Leading to a budget shortfall.  Which leaves them with two choices.  Cut spending.  Or borrow money.

Well, people rarely vote for people that take stuff away from them.  So the politicians borrow money.  And they keep borrowing money.  Because their spending obligations were based on the rosiest of projections of economic activity.  Which rarely happens in real life.  So they borrow.  And they borrow more.  Soon they have to borrow to pay the interest on what they’ve borrowed previously.  Soon the debt grows so great that the credit rating agencies lower their credit rating.  Making future borrowing more expensive as they have to pay a higher interest rate.  Some may turn to higher tax rates.  But that also lowers economic activity.  Which reduces overall tax revenue.  Some may turn to printing money. Which also lowers economic activity.  And overall tax revenues.  By causing inflation.  And raising prices.  Which eventually leads a country down the road to bankruptcy.  And on their knees begging for a bailout.  Which is the ultimate destination for all nations with excessive government spending.  To throw themselves on the mercy of those countries who have lived within their means.  Which rarely ends well.  Because they expect the bankrupt country to start living within their means.  Meaning austerity.  Which the people accustomed to generous government spending are not too keen on in the least.  And often reply to austerity demands with a little rioting in the streets.

There is one simple way to avoid all of these troubles, though.  All a nation has to do is NOT spend so much.  If they do then they will never have a financial crisis.  For a country never went bankrupt by spending too little.

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