Can Governments Spend Your Money Better Than You?

A standard objection to tax and spend policies is ‘how can the government know what to spend better than millions of individuals?’ Allow me to try and provide an answer to this question.

Firstly, the truth of modern capitalist economies is that large amounts of the process of production go towards creating demand that wouldn’t formerly be there – advertising, marketing and so forth. Standard rebuttals to this point tend to rest on the idea that people behave like perfectly logical robots, but the fact is that people are influenced by advertising to buy things they didn’t previously know they wanted – if they weren’t, it wouldn’t exist. So a decent proportion of private spending is ‘artificially’ created, and hence people wouldn’t miss it if it were gone.

Secondly, consumption tends not to increase happiness past a certain point, as humans fall victim to two cognitive biases that, as Jonathan Aldred says, put them on the ‘happiness treadmill’:

  • Adaptation. This is when people become accustomed to new things they have, and their happiness level adjusts back to where it was previously. This is pretty extensively documented – there are many examples of lottery winners who do not feel any happier than previously, and there is the well known phenomenon of ‘buyer’s remorse‘.
  • Rivalry. This is the fact that a large part of our desires for consumption rest on what we see around us and what our neighbours have – ‘keeping up with the Joneses‘.

So people buy things because others have them, and quickly adapt, resulting in no net gain of happiness or utility. This continues, fuelled by advertising, and growing consumption fails to deliver the goods, so to speak. Hence, reducing people’s private purchasing power does not necessarily make them less happy, though of course it depends on the stage of development and on the type of good.

Even if you accept this, you might ask ‘well how can the government improve on this once it has the money?’ The answer is actually very simple, neoclassical (!) economic theory: the government provides public or quasi public goods, which would be under provided or not provided at all in the private sector. Private individuals do not have the incentive to provide these goods, so the government is required to step in. After all, it’s better than spending money on things for which demand has been artificially created, and which do not appear to increase people’s happiness.

The idea that governments can spend money better than the private sector has been suggested as as a reason for high tax rates appearing to be a net positive for economic growth, though there are numerous other possible explanations. It also may help to explain the relative success of the Scandinavian economies, where consumption (and other) taxes are high and advertising is strictly regulated. As a result, consumerism is lower and public services are, broadly speaking, the best and most well-funded in the world.

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  1. #1 by atm0spheric on March 3, 2012 - 3:16 pm

    I think you have a typo in:

    or not provided at all in the public sector.

    It makes more sense as the private sector.

    Cheers

    EV

  2. #3 by MoneyTowardHappiness (@econ4what) on March 3, 2012 - 3:55 pm

    Money Toward Happiness? Who’s money are you spending?

    • #4 by Unlearningecon on March 3, 2012 - 4:05 pm

      No offence but I don’t really understand the point of your comment. Based on your Twitter I’m assuming you’re not a spammer so I’ll let you through, but try to make more sense in the future.

      • #5 by MoneyTowardHappiness (@econ4what) on March 3, 2012 - 4:19 pm

        I wrote a book on this exact subject and can follow most of your article but the title is unclear to me. “Can Governments Spend Your Money Better Than You?”. When you say ‘your money’: does this mean the government would first have to take (tax) to get your money and then spend it?

      • #6 by Unlearningecon on March 3, 2012 - 4:35 pm

        Yes, I’m just paraphrasing the mantra that ‘governments cannot spend your money better than you’ often parroted by libertarians etc.

        Of course, the question of whether taxed money is ‘your’ money is up for debate, but for the purposes of this post I thought it would work as a rhetorical device.

  3. #7 by Leigh Caldwell (@leighblue) on March 3, 2012 - 6:09 pm

    I thought you didn’t believe in neoclassical economic theory :)

    • #8 by Unlearningecon on March 3, 2012 - 6:14 pm

      Ha, I think externalities are an area where it is OKish, although I object to that standard supply-demand representation of internalising them, and I’d prefer for the economy to be inside the environment than it be called an ‘externality’.

      I also object to the way public goods are deemed to have been taxed out of the economy and provided, rather than being essential to the creation of the economy in the first place.

      Actually, I object to the way health and education are modelled as ‘ordinary’ goods/services, too.

      Basically, I object to the framing, but the central message about private versus public costs/benefits and under/overprovision is agreeable.

      • #9 by JMRJ on March 3, 2012 - 8:01 pm

        >>I also object to the way public goods are deemed to have been taxed out of the economy and provided, rather than being essential to the creation of the economy in the first place.<<

        Insightful. I often think of subways. I read somewhere that they cost about $1 billion per kilometer – very capital intensive. They would never make a profit in and of themselves, but densely populated modern cities would be almost impossible without them.

        Some government services are, I agree, rightly regarded as structural support for private economic activity, like a pre-condition, not an expense.

        But of course there are limits. Seems folly to be dogmatic one way or the other.

  4. #10 by Caleb on March 3, 2012 - 8:15 pm

    1. How is demand created by advertising “artificial” by any meaningful definition of that term? Isn’t all human activity ultimately endogenous? Or are you saying that the cycle of desire creation then fulfillment lacks some kind of objective or legitimate value?

    I liken the advertising-consumption cycle to the environment created by highly addictive, goal oriented video games. (Think WOW.) The players of said games did not know they wanted to achieve Level 80 (or whatever) until the game environment was created and introduced to them. But once introduced, they pour large amounts of resources into achieving these “artificial” goals. Are you saying that this process lacks value or utility? How do you know? On what basis to make that assertion? Are you saying that it should be discouraged, by appropriation of resources if necessary, for other more noble ends?

    2. I think your point about adaption and rivalry lacks any useful explanatory power. They are applicable only in purely relative relations. Why wouldn’t adaption and rivalry apply just as much to consumption of “public” goods as consumption of “private” ones? After all, consumption is consumption, regardless of its source.Likewise, why does development level matter? Adoption applies whether you go from a stone spear point to a bronze spear point just as much as if you go from an Ipad to an Ipad2. Rivalry applies whether it’s your cave or your McMansion that’s bigger than your neighbor’s. You’re missing an important element here, and leaving it out is deceptive.

  5. #11 by Caleb on March 3, 2012 - 8:29 pm

    Ah, I knew I had a third point. Just remembered it.

    3. What do you think the relevant countervailing considerations are? (I’m assuming you knowledge some, because you don’t seem to advocate a complete command and control economy. If I’m wrong, tell me.) So what forces and conditions mitigate against wholesale appropriation and assignment? How do you know that they interact with the “neoclassical” market failure considerations so as to form evidence for your desired level of public expenditure? (What ever that may be.) More pragmatically, how do we construct a legal apparatus that discovers and implements this ratio reliably without massively outweighing any benefits with its inevitable costs?

  6. #12 by Unlearningecon on March 4, 2012 - 3:16 pm

    Caleb,

    1. Addiction is a tricky one. I certainly wouldn’t advocate the ridiculous rational addict hypothesis:

    http://www.xtranormal.com/watch/7873033/mulberry-bag-will-develop-for-everyone

    But if you consider certain drugs, having them legalised and unregulated would result in drug companies pushing them at people trying to get half the population addicted so that they could make a profit. WoW is a less extreme example (and incidentally it’s mostly played by kids so parents have a big say) but there are a lot of examples of people regretting playing video games so much.

    You sort of work on a ‘people choose to do this so leave them be’ framework, which is OK up to a point but you have to remember that people’s decisions aren’t neutral and are influenced by a variety of factors, including corporations with considerable market power. Advertising is an example of influencing people’s decisions, the same way as a regulation might, and so my objection to it is actually on similar ‘leave people alone’ grounds.

    Perhaps ‘artificial’ is a misnomer, but the fact is that demand for these goods is created by the very corporations whom it benefits. In absence of the adverts/marketing, people would not miss this stuff, and evidence suggests that its existence is not increasing their happiness. Hence, I don’t know why we should structure our economy to around consumption at this level, which we clearly do.

    2. No, adaptation doesn’t apply at a low development level. If you give a starving child some food every day, you can be pretty sure he will remain happier than in its absence. However, there is a certain point where increases in consumption fail to increase happiness.

    As for private versus public, are you familiar with Maslow’s hierarchy of human needs? Naturally the state can’t help everybody become completely enlightened but things like education and good environments (playgrounds etc.) are more likely to help people move up the hierarchy and attain more sustained increases in happiness than a car with some new feature that they didn’t desire before it was implemented.

    3. I’m not 100% sure of your point. Obviously the efficacy of statist policies can be questioned, so the fact that a certain area of the economy is flawed may not be grounds for intervention. However, I feel the existence and relative success of the Social Democratic states suggests that we can do pretty well with a large state.

  7. #13 by Caleb on March 5, 2012 - 10:47 pm

    1. (a)Decisions are not neutral, agreed. I would go farther, and say that any grounds for evaluating decisions are not neutral, either.

    Chemical addiction is certainly one aspect of the issue, but it wasn’t the one I was getting at. (Perhaps “addiction” is a misnomer.) I am referring to the weak form of “addiction” which could mean any human activity which people pursue for its own sake, rather than for some purpose outside of it. The vast majority of these activities are created and marketed by persons who benefit directly from having people participate in them. My point is that if you label this construct “artificial” (I think I know what you mean by that term), then you have labeled a significant portion of human activity “artificial.” (And therefore, implicitly, expendable.) Perhaps this is what you meant to do: “…I don’t know why we should structure our economy to around consumption at this level…”

    (b) I question your implied premise: “If people would be just as happy without something as with it, then that something lacks value.” This strikes me as almost certainly wrong on an intuitive level. For example: I’m a pretty happy guy. I can be content in nearly any social situation I find myself in. I can live for years by myself, or not, and be equally content. Chances are, if I had never met my wife, and were still living alone today, I’d be just about as happy as I am know. (I have a great marriage, so I’m hesitant to say that I could be happier. But it is possible.) Yet my acknowledgement of this counter-factual does not lead me to assert that these two possible realities are value-equal. Status quo bias? Maybe. But there is a difference between explaining, and explaining away. If you relegate these types of value decisions into the “cognitive bias, and therefore irrelevant” category, you will nullify much of what most humans consider valuable.

    (c) I should note that, aesthetically, I agree with you on advertising and consumerism. I can’t stand commercials, and I hate products designed for status consumption. So I, uh, don’t watch TV. And I never go within a mile of the mall. Your analogy with regulation here breaks down. If I want to practice unlicensed pet grooming in a state that prohibits it, I sadly cannot tell law enforcement to bug off the same way I can with advertisers.

    2.(a) I think I misunderstood your definition of “development.” I understood you to mean the overall development of a given economy. (Hunter-gatherer, agrarian, feudal, industrial, post industrial, ect.) Yes, not starving is better than starving. But every level of human society has largely met the minimal needs of most its members. Most anthropological studies I’ve seen show that hunter-gather societies had pretty much the same level and distribution of human happiness as any modern one, so long as they were isolated from the latter. I saw a study a few years back that said the citizens of Nigeria were the happiest on the planet. Here’s where I think your adoption and rivalry analysis falls short. If “happiness” were measured only within the considerations of adoption and rivalry, there is nothing to recommend a post-industrial economy over a hunter-gatherer one, or a sufficiently isolated underdeveloped nation over a developed one.

    (b) I am familiar of Maslow’s hierarchy, and I am as critical of it as you are of neoclassical economics. Okay, perhaps not as critical, but I think it grossly oversimplifies the enormous possible range of varying human hierarchy of values . There are simply too many examples of people “inverting the pyramid” or otherwise acting in ways that other people simply cannot understand for Maslow’s hierarchy to be anything but a crude heuristic.

    What I’m trying to get at is your underlying hierarchy of values. When you assert that some public good is superior to some range of private goods, you are making a dual assertion about the underlying value hierarchies of everyone involved. First is that the entire range of possible consumption of private goods does not garner any more utility to their consumers than consumption of the elected public good. This may or may not be the case. Second is that the person or entity making this assertion can in fact determine that this is indeed the case within a probability that justifies taking the risk. This second assertion does more than run you into a massive information problem. It also requires the entity in charge to evaluate everyone else’s hierarchy of values by some objective standard. It requires prioritization of values on a meta-level. Hence, I believe, your dismissal of “artificial” human endeavors.

    Let’s say that Maslow’s hierarchy is the be-all-end-all of ranking human values. Then the second prong is easily satisfied, no? And the first is simply a matter of social calculation. So then whence all the disagreement? You can’t tell me it’s a collective action problem, because government is supposed to solve those. So why doesn’t everyone else sit down and shut up, knowing that fulfilling Maslow’s hierarchy (or any other, for that matter) is the ultimate goal, and that collective action is the best way to get there? The alternative is that there is no ultimate hierarchy, and people really and truly disagree as to the ultimate common good.

    3. My question isn’t about the efficiency (or success, it looks like you are using these term interchangeably) of any one single policy. It’s how you measure “success” to begin with, and how you propose to implement a system that best reaches what you define as success.

    One point I take serious issue with is equating the laws of a nation with its “success” without taking anything else into the equation. For example, Scandinavian nations are very successful, by Scandinavian definitions. But Scandinavian nations are very small and very culturally homogenous. In small, culturally homogenous nations, it is relatively easy for the vast majority of the population to agree on what the correct hierarchy of values is. Thus, it is easier to coordinate legal and social endeavors into one big whole. But in a nation like the US, you have a huge variety of what people think the goal of society is.

    Saying that adopting the Swedish legal system will give us Swedish results is just as ridiculous as saying that adopting the Swedish legal will turn us into Swedes.

    • #14 by Leigh Caldwell (@leighblue) on March 6, 2012 - 1:49 am

      Are you on Chrome? Sometimes if you create a new tab and click on the ‘Recently closed’ popup menu, then reopen the page you just closed, it will still have whatever you filled out visible in the form.

      Not always, I admit. Anyway I look forward to your reply, because Caleb has articulated a number of concerns I share. From a “left” point of view, I completely agree with the need for public goods and public investment, as well as the importance of redistribution (if nothing else, because of the higher utility from wealth enjoyed by poorer people). And yet I also see the Hayekian/libertarian points about subjective value, knowledge constraints and the danger of imposing a value system from above, as well as the more conventional supply-side objection to the incentive damage from redistribution.

      If I could suggest a clarification to Caleb’s point 3, from a previous comment, it might be simply this:
      – we can agree that public goods are necessary; but _how much_ of them is necessary? Should we spend all of society’s resources on them, or just 1%, or somewhere in between; and how do you work out the right threshold?

    • #15 by Caleb on March 6, 2012 - 2:00 am

      D’oh! I feel your pain.

    • #16 by Unlearningecon on March 8, 2012 - 1:19 am

      Thanks Leigh, unfortunately I waited too long so it wasn’t on the recently closed tabs :(

      OK so I have recovered from the other day and am prepared to type the same thing out again.

      Caleb,

      You make some good points about happiness and about external influences on consumption, but I think we can take a somewhat objective stance on whether advertising is influencing people’s wants or desires for the better, in the same way we might take a somewhat objective stance on binge drinking culture or certain religion’s treatment of women. Aldred actually makes the point about rivalry and adaptation far better than me (and takes a longer time doing it), but he argues that current consumption puts people on a happiness treadmill, where they always need the next thing, then once they get it they are no more satisfied. Intuitively this seems correct to me, and I think regulating advertising more strictly would be one step towards stopping it.

      Also with video game addiction, bear in mind that playing video games has been shown to increase dopamine levels, so it’s also somewhat chemical. Having said that, I’m not exactly sure what I would do about computer games – it’s mostly kids so the parents have a big role, and I certainly wouldn’t advocate anything as Orwellian as state regulation of computer game hours. But I do think aggressive marketing strategies need to be targeted.

      1. (c) is strange. You say that you hate consumerism and can’t to certain activities because of it, and have to actively avoid, but you seem to think this is an argument against regulation of advertising? And I guess everyone could do what you do, but then there are a lot of things everyone could do that would eliminate the need for legislation. The problem is that people don’t have the individual capacity or incentive to do them, which is why we have laws in the first place.

      There are also some things that you simply can’t escape from, such as companies putting impulse buy items next to the till and framing deals certain ways to make people buy more. Sure, you could appeal to individual responsibility, but the fact is that, on average, these things influence people, otherwise companies wouldn’t do them.

      Your second section reads like a more nuanced version of ‘how can some state bureaucrat decide what’s best for me?’ You are sort of assuming neutrality in the absence of the state, but there are a lot of influences on people’s behaviour that affect their values. Ultimately the best we can do is try to make some decisions about what we allocate resources to collectively – it doesn’t work for everybody, but then, I’m not sure any system does, including consumer sovereignty. I appreciate this isn’t the most robust defence of representative democracy ever, but I just don’t think a system that makes no assumptions about/has no influence on every individuals values is possible.

      I believe some polls from Sweden show that most do not want lower taxes and lower spending, though I cannot find them so don’t hold me to it.

      3. (I said efficacy, btw)

      I agree with you about the complexity of cross country evaluation but there are other examples of successful social democratic countries in Central Europe (present crisis excluded) and the post-WW2 period was also far better in Anglo-American countries. Furthermore, my point wasn’t so much ‘Sweden is like this, let’s do that too!’ but more ‘this is a problem, and here’s how we can solve it, and here are examples of countries that have done that successfully’ – unfortunately we don’t have much more evidence than that in politics/economics.

      • #17 by Caleb on March 11, 2012 - 12:00 am

        1. (a) I certainly agree that can take a stance on things like advertising, binge drinking, or treatment of women. But I very much doubt that those stances are in any way objective.

        Let’s take binge drinking as an example. Say there is a young man; single, steady job, pays for own health insurance, ect. In every way normal, except that his “hobby” is getting blitzed every evening. (At a local bar within walking distance of his home.) Yet, if he can control the negative external effects of his pastime (doesn’t drive drunk, can perform his work duties, can pay for all health expenses), what objective hold do you have over his behavior? What factor gives you purchase? True, you, I and many others many agree that his behavior is not beneficial. But he obviously disagrees, and probably isn’t alone.

        Let’s go the other way. Forget binge drinking, what about what we consider “normal” alcohol consumption? Except for a few (rather dubious) studies about the benefits of red wine, the science pretty much shows that the most healthy level of alcohol consumption is ‘none.’ Yet people still do it, even after we made it illegal a while back. (And I’m not saying this choice is neutral. Social conditioning, peer groups, substance dependency, genetics, and yes, advertising, all play into this choice.) Alcohol consumption also does not do anything to raise overall levels of happiness. We almost certainly would not miss it if it had never existed. More consumption does not make you happier (often, quite the opposite), yet many people insist on increasing their consumption. So why should we countenance alcohol consumption at all?

        1. (b) I’ll have to get Aldred’s book, maybe it will have a better answer to my objections. But the observation that conspicuous consumption puts people on a “happiness treadmill, where they always need the next thing, then once they get it they are no more satisfied,” seems to me to be a fairly apt description of the entirety of the human condition in the most universal sense. That vicious cycle of constant striving and an ultimate unsatisfactory outcome is a recurrent theme throughout human literature and philosophy. (Read the book of Ecclesiastes, by far the best book in the Bible.) So when you and Aldred criticize consumerism for failing to increase human happiness, my reaction is decidedly unimpressed because that failure is universal throughout all human endeavors.

        1.(c) “You say that you hate consumerism and can’t to certain activities because of it, and have to actively avoid, but you seem to think this is an argument against regulation of advertising?”

        Absolutely. I also can’t stand it when people chew gum loudly, wear aviator sunglasses, say that Will Ferrell is funny, or paint their mailboxes bright pink. I’m pretty sure I could get a plurality of the population to agree with me on any one of these things. But I don’t want the government to control these things, either.

        “And I guess everyone could do what you do, but then there are a lot of things everyone could do that would eliminate the need for legislation.”

        Exactly.

        “Sure, you could appeal to individual responsibility, but the fact is that, on average, these things influence people, otherwise companies wouldn’t do them.”

        Of course they do. I’m not arguing about that. I asking why that influence is a bad thing.

        2. (a)Once again, I do not assume neutral behavior. In fact, I don’t think such a thing exists. But just because a choice is not neutral and has external influences does not mean it lacks value.

        (b)”Ultimately the best we can do is try to make some decisions about what we allocate resources to collectively…”

        This is a very broad assertion, it could mean a huge range of things. By the most extensive definition, consumer sovereignty IS collective decision making. I have a feeling you mean something a bit more specific. You should state what that is, rather than making sweeping, generally appealing assertions. The devil is always in the details.

        3. “I believe some polls from Sweden show that most do not want lower taxes and lower spending”

        My point exactly.

        “unfortunately we don’t have much more evidence than that in politics/economics.”

        This is the rub. All the “evidence” we do have is inherently conditional: on time, on culture, and on an near infinite number of unseen, unforeseen, and unknown chaotic variables. All broad policy discussions should begin with this disclaimer of conditional relevance.

      • #18 by Unlearningecon on March 12, 2012 - 4:52 pm

        1. (a) OK I’m not an addiction expert so I’ll be brief:

        There are examples of people who should be free to do what they want. There are also examples of people who have been exploited and deliberately hooked on things for the profit of their dealers. Whilst it’s hard to draw the line, I’d venture that the former guy would do it in the absence of aggressive advertising and marketing, which wouldn’t interfere with his freedom to do so at all.

        (b) The problem is that producing goods that have to have demand created for them creates environmental and resource constraint problems, and requires work. Why increase consumption, not reduce work hours? Capitalism doesn’t leave the freedom for people to choose – working hours have been the same for a long time and are actually going up.

        (c) Come on, that argument is poor by your standards. Obviously some things don’t need legislation and some do. The line is blurry, but allow me to take a strong position: I don’t think it’s fair for individuals to have to avoid advertising and marketing, which is created by relatively few large firms and which impact everybody’s lives. I think legislation is warranted.

        2. OK, well if we agree that consumer sovereignty is not a ‘natural’ state but manufactured, same as any other decision making process, then we don’t disagree here?

        3. But does that mean the evidence I presented is worth nothing? I don’t think that’s fair.

        EDIT: I should add that, although I agree that because something doesn’t increase happiness doesn’t make it worthless, this doesn’t imply that increasing happiness is worthless, right? And it appears the less consumer-y countries are among the happiest:

        http://www.financialjesus.com/how-to-get-rich/top-10-happiest-countries/

  8. #19 by Min on March 7, 2012 - 8:16 pm

    The gov’t can’t spend my money because it does not have my money. Even if I pay taxes. To think otherwise is the poker pot fallacy. Once your money goes into the pot, it is not yours anymore. The belief that it is causes irrational behavior.

    (The fact that, nowadays, paying taxes does not transfer money to the national gov’t is a different matter. Taxes are accounted for, so we can think of taxes as funding gov’t spending. But it is not “my” money anymore.)

    • #20 by Unlearningecon on March 8, 2012 - 12:30 am

      Of course this is true but I just wanted to use a turn of phrase.

      • #21 by Min on March 8, 2012 - 1:37 am

        Sorry, my note was not aimed at you, but at those who think that way. :)

  9. #22 by isomorphismes on March 21, 2012 - 4:33 am

    Well said, and a point that does need to be articulated.

    large amounts of the process of production go towards creating demand that wouldn’t formerly be there – advertising, marketing and so forth.

    Inventions as well; bringing an exotic product/service to a new market; butnot process innovations that merely lower costs for extant goods.

    Inventions that don’t “create new demand” include medical devices (also new medical knowledge) and energy / power generation. Crucially, these are areas where government research money often goes.

  10. #23 by isomorphismes on March 21, 2012 - 4:36 am

    people behave like perfectly logical robots

    A misconstrual.

    Acting like your utility function is Σu(ci) • βi would not be very logical if your utility function actually has a quite different shape.

  11. #27 by isomorphismes on March 21, 2012 - 4:38 am

    So a decent proportion of private spending is ‘artificially’ created, and hence people wouldn’t miss it if it were gone.

    You mean if it were never created in the first place. Unfortunately Americans now consider smart-phones vital and they would miss them if they became 10× more expensive.

  12. #29 by isomorphismes on March 21, 2012 - 4:41 am

    UL, one other way government can spend the money better is if the private sector experiences shocks to supply or demand — say these are “artificial” or “wrong” in some sense rather than real business cycles — then gov’t can borrow cheaply to finance temporary demand/supply. (no political economy here, just a tiny model)

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