The Decreasing Cost of Increased Government Spend

WASHINGTON, DC - DECEMBER 17:   US Treasury Se...

WASHINGTON, DC -  US Treasury Secretary Tim Geithner and Larry Summers  (Image credit: Getty Images via @daylife)

The Atlantic’s Matthew O’Brien has an interesting analysis of a new paper by former Clinton Treasury Secretary and Obama economic advisor Larry Summers and Brad DeLong of the University of California. Summers and DeLong argue that, under certain circumstances such as America faces today, government spending can provide enough of a boost to economic growth that it actually pays for itself. 

As summarized by O’Brien: “With interest rates at zero, the normal rules do not apply. Government spending can put people back to work and prevent the long-term unemployed from becoming unemployable…If people are out of work for too long, they lose skills, which makes employers less likely to hire them, which makes them lose even more skills, and so on, and so on…High unemployment is a symptom of a collapse in investment. If we don’t make needed investments now, that will put a brake on growth down the line. Together, economists call these twin menaces hysteresis…Assuming that spending can forestall hysteresis, then this spending might be self-financing. In other words, spending now might ‘cost’ us less than not acting.”

In other words, if long-term unemployment brought on by a lack of investment is severe enough, it can cause economic growth to decline by more than the cost of government spending designed to alleviate unemployment. To those who say all of this sounds a lot like Republican supply-side claims that tax cuts can pay for themselves by boosting economic growth – a proposition many Democrats have mocked since the Reagan Administration – O’Brien counters that the Summers-DeLong hypothesis applies only in rare times – and “this looks like one of those rare times.”