MMP Blog #36: What Government Ought to Do: An Introduction

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Originally published February 12, 2012 on the New Economic Perspectives blog.

In the next series of blogs we will turn to what government ought to do. This series will specifically treat only sovereign government—one that issues its own currency. From the earlier blogs, that will make it clear that we are addressing only a government that does not face an affordability constraint.

In these upcoming blogs we will examine alternative views about the proper role for government—given that it can “afford” anything for sale in its own currency. We first look at four reasons why government spending ought to be constrained. We then compare and contrast a typical “conservative” versus “liberal” view about the scope of government. (These terms are used in the American sense—that are somewhat idiosyncratic. In America, conservative is closer to what is called “liberal” or “neoliberal” abroad. Liberal in America is closer to “social democratic” or to “labor party” abroad.)

We will work toward developing an example of a government program that is consistent with the MMT view of sovereign money—one that uses the principles we have established in previous chapters to resolve the problem of unemployment in a manner that is consistent with both the liberal and the conservative views. That is the employer of last resort or job guarantee approach. I will conclude this series with my own view on whether MMT must include the ELR/JG proposal.

Warning: when we address views on what government ought to do, we have moved beyond description. My views of what government ought to do need not be accepted by others, even those who fully understand MMT. I will be making policy recommendations that are consistent with MMT. You do not have to like mine; you can come up with your own. I will devote a blog to an Austrian approach to policy-making, and its goals will be different from my own.

Just Because Government Can Afford to Spend, Does Not Mean Government Ought to Spend

Understanding how government spends leads to the conclusion that affordability is not really the issue—government can always afford the “keystrokes” necessary to make expenditures as desired. But that does not mean it should. We can list several legitimate reasons for constraining government spending:

  • too much spending can cause inflation
  • too much spending could pressure the exchange rate
  • too much spending by government might leave too few resources for private interests
  • government should not do everything—impacts on incentives could be perverse
  • budgeting provides a lever to manage and evaluate government projects

For example, suppose government decides to newly hire 1000 rocket scientists for an expedition to Pluto. Our first consideration is whether there are 1000 rocket scientists available for hire with the necessary skills. Even if government can afford its desired spending plan that does not mean it can accomplish its mission if the resources are not available. In other words, the government always faces a “real resource” constraint: do the resources exist, and are they for sale or hire? Related to this consideration: are the existing infrastructure, technology, and knowledge up to the task of achieving program goals. That, of course, is an important question. Let us presume that these conditions are met.

The second consideration, then, concerns competition with alternative uses of the resources, what is called the “opportunity cost”. If those 1000 rocket scientists would otherwise be unemployed, then the opportunity cost of hiring them for the Pluto mission is low or zero. (We might find, for example, that if they were not employed they would take care of their children at home so the non-zero opportunity cost of employing them is the value of the foregone childcare services. You get the picture—it is not likely that opportunity costs are zero, but for unemployed labor they are probably low relative to benefits of employment in appropriate jobs.)

More importantly, it is likely that many or most of them are already working, either in the private sector or on other government projects. Since sovereign government does not face an affordability constraint, it can win a bidding war against the private sector if it chooses to do so. In that case, it will push up the wages of rocket scientists so high that the private sector gives up and hires workers with other credentials. The impacts on the private sector could be complex—likely leading to higher wages, higher product costs, and even less output in those sectors that use rocket scientists and other skilled workers who can substitute to some degree for rocket scientists (perhaps for some purposes, other types of engineers are almost as good, so firms bid up their wages). At the very least, the Pluto mission could lead to “bottlenecks”—relative shortages of key resources—and some (perhaps limited) price hikes. In that case, public policy must consider the much greater opportunity cost of hiring rocket scientists away from other employment.

In addition, other wages and prices might be increased through spill-over effects if a new government program is so big that it sets off a general bidding war for labor and other resources. For example, during a major war like WWII, government not only conscripts workers into the military but it also redirects resources to production for the war effort. Without rationing and wage and price controls, it is relatively easy for this to lead to a general price and wage inflation. Note that it does not take a major war for this to happen. If government spending pushes the economy to, and beyond, full employment it is likely that inflation will result even in the absence of a major war. At the same time, high domestic employment and income can—under some circumstances—lead to a trade deficit (as domestic demand for imports rises relative to foreign demand for exports—discussed in the previous section). This might then pressure exchange rates (although the correlation between trade deficits and exchange rate depreciation is far from certain).

Hence, while government can afford to spend more, it must weigh the consequences in terms of withdrawing resources from other (perhaps more desirable) uses, as well as possible impacts on prices and exchange rates.
There are many other reasons to constrain government spending. For example, conservatives often argue that spending on “welfare” affects incentives. A strong social safety net might send the signal that individuals do not really need to work because they can always live well enough on government hand-outs. Or, government bail-outs of business might encourage management to take excessive risks on the belief that no matter what happens, government will cover the firm’s losses.

Further, a corrupt government might spend on programs that help friends, but refuse to do anything to assist more deserving groups—what is often called “crony capitalism”.  So, there could be complex and even unintended consequences of government programs.

All of that must be considered when undertaking government spending programs—and negative consequences raise legitimate concerns about the size of government spending, not due to the (im)possibility of insolvency but rather to undesired (and unknown) effects of government programs.

Finally, governments should, and do, use budgets, which are a form of self-imposed constraint. Typically, the elected representatives will allocate a sum to be spent on a particular project. Program managers are then held accountable for finishing the project within the budgeted amount. Over-running the budget can be used as an indication of mismanagement. The budgeting process also helps to reduce the incentive for “mission creep”, expanding the project to enhance the manager’s power and prestige. In other words, budgeting by sovereign government provides a useful mechanism for project control and evaluation.

We conclude this section by observing that absence of an “affordability” constraint does not imply that government ought to spend without constraint. As we discuss in the next blog, its spending ought to be aimed toward achieving the “public purpose”. 

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