Government Spending: A Cure for Unemployment

All over the world, governments are held accountable for the unemployment rates prevalent in their country. It is as if, the government’s main duty is not to govern but rather to provide employment to every willing person in the country. Therefore, whenever unemployment rears its ugly head, governments find themselves under increasing pressure to change the situation or else face the wrath of the public. In the past century or so, governments have resorted to a technique called government spending to achieve these objectives. In this article, we will take a closer look at what government spending is and what are its pros and cons.

The Main Cause: Market Sentiments

To solve the problem of unemployment, we need to reiterate its root cause. Unemployment does not happen because of a change to the factors of production. The factors of production are all there, unchanged. It is the market sentiment that really causes unemployment. More and more people fear job loss and this fear turns into a self fulfilling prophecy. Fear of job loss results in spending cuts. Spending cuts are followed by production cuts and then by the dreaded job loss. The idea is to reverse the process at the stage of spending cuts. The idea is to raise the market sentiment and prevent the self fulfilling prophecy from becoming true.

Government and Spending Expansion

In most countries, governments are the single largest consumer in the country. Government spending accounts for 30% - 40% of the GDP of many countries in the world today. Hence, governments have a large influence on the spending patterns and can alter them. Even in countries where governments do not interfere much with the economy, they certainly have powers to legislate laws and do so if they see fit.

Therefore when the negative sentiment in the market begins to rise and people cut their spending, governments have the power and the ability to counter these negative sentiments with their own spending. The size of the government ensures that it can more than compensate for the spending cuts undertaken by the individuals.

Hence the spending cuts by the individuals are counterattacked by spending rise by the government, keeping production and consumption constant and ensuring no job loss.

Pros of Government Spending

This approach to increasing government spending has become wildly popular in the past couple of centuries because it has certain merits. Let’s first discuss the merits of this approach:

• Prevention of Recession: The “r” word is probably the most feared word in economics. People like a smooth life and would like to avoid recession at any cost. Government spending provides a way to accomplish this. As mentioned above, government spending prevents negative sentiments from rising and creating a downward spiral. Hence, this approach prevents job loss in the short and medium run making it a popular “fix it now” measure.

• Immediate Revival of the Economy: Not only does government spending prevent recession, it can also reverse the effects of recession. An economy in turmoil can get an immediate lease of life with these government measures.

• Sustained Revival: The measures used by government act instantly. However, their effect does not wear out instantly. Once the positive sentiment has been restored, the government can cut the excess spending gradually. Private spending replaces public spending as market sentiment rises and confident consumers rush in to buy more goods and services. In the medium to short run, the economy sustains itself.

Cons of Government Spending

Even though many economists believe that unemployment can be controlled by government spending, we still have unparalleled levels of unemployment in the world. Developing countries like the United States and Europe are facing unprecedented levels of unemployment. The reason behind this is that government spending too has certain drawbacks. Let’s discuss them in this article:

• Financed by Debt: Most of the government spending in the world is financed by debt. Governments usually do not have enough money to run their day to day operations. The question of having excess money to spend on economic revival is simply ridiculous since there is no excess money! The problem with money spent after borrowing is that sooner or later, the interest catches up. In the long term a situation is created when the downward spiral begins to rise. But the government has so much debt from the previous attempts to manage unemployment, that it can do very little to rectify the situation this time.

• Unproductive: Secondly, there is an inherent difference between projects financed by the government and by private parties. Since private parties have their own money involved, they spend it on creating projects which are sustainable and provide a positive cash flow in the long run. However, governments do not face any such compulsions. In fact most of the projects undertaken by the government are haphazard and downright unproductive.

  The money is spent, not with the idea of creating a self sustaining economic system. Rather the money is spent to put more and more money in the hands of the consumers via wages, rents and profits. A combination of borrowing money and spending it on unsustainable projects is a recipe for disaster in the long run.

• Political Considerations: Thirdly, government money is spent with ulterior motives. Governments all over the world spend money to provide benefits to a certain section of society that finances them during election campaigns. In rare cases like Greece, 25% of the people were appointed to government jobs and given salaries even though there were no tasks to be accomplished. In the name of eradicating unemployment, the Greek government was institutionalizing it. No private party could have done a similar thing and stayed afloat for as long as the Greek government.

• Corruption: Lastly, governments spend other people’s money and as Milton Friedman once put it, “nobody spends other people’s money like they spend their own”. Government money i.e. public money collected via taxes is usually spent without consideration. Many cases have emerged wherein there have been private benefactors to government deals. Cases pertaining to the scams in India as well as the defense lobby in the United States are well known worldwide. The points related to corruption cannot be emphasized enough and it is one of the main reasons as to why government spending does not seem to work.

Conclusion

To conclude, government spending is theoretically a great way to counter unemployment and revive the economy. In theory, it seems like the method will work without any questions. However, as we have seen in practice there are a wide variety of issues that prevent this policy from being effective.

Also, it needs to be considered that the past is the best indicator of the future. In the past, countries like United States and Europe have extensively used government spending as a tool. This enables them to avoid unemployment in the short and medium term. However, as it turned out, they were just delaying the inevitable. Hence, government spending should be seen as a short term fix, the overuse of which can cause long term problems which are extremely difficult and painful to cure.

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.