A friend asked me this just a bit ago, and my response was lengthy and straight baller, so I had to make it its own post.
There are two main problems of government spending. The first is that you don’t get your moneys worth. When you spend your own money on yourself you care what you get and you care what you pay. When you spend your own money on someone else, you still care what they get (but not nearly as much and are less capable of determining what they need) and you care what you spend. When you spend other peoples money on yourself you dont care the cost, but you care what you get. But when you spend other peoples money on other people, you neither care what you get nor what you spend. Of course in situations where natural monopolies exist or where redundancy is inefficient, public goods are preferred because the problems associated with them are less than the problems of monopoly and redundancy.
The second reason why government spending is bad is that it creates malinvestment. The market allocates resources to best deal with people’s desires. When the government steps in for example, to encourage house ownership, we end up with soaring house costs, overbuilding, and all the rest, leading eventually to its destruction.
This is true in both the boom and the bust. Its obvious to see how this is a problem in the boom, but less obvious in the bust (but no less true). The government does not increase the economy, it simply allocates resources to where they desire. They can only spend what they take whether through inflation or taxation. The money they take would either be saved or spent. Money spent by individuals would be spent more efficiently. Money saved by individuals, is not money destroyed, but rather money able to be invested. If we had no federal reserve to manipulate the market, we would instead find that the boom is kept in check by consumer spending competing with investment. The bust would be kept in check by falling consumer spending allowing more money to be available for investment. The simple supply demand curve for the price of money would make it so that in booms the interest rate would rise to insane amounts, while in the bust it would fall to nearly zero. Thus the market regulates itself (not perfectly because people are not always rational and informed, but much better than a central authority can regulate it).
The boom is generally created through government by malinvestment. This is the problem. The bust is the cure by removing worthless investments (along with good investments too, but this is an unfortunate by-stander in the boom bust cycle). The longer you delay the cure, the longer the patient will be sick. We have a dope-fiend economy, continually injecting easy credit. Well now we are dope-sick. The addict thinks the cure is just a ‘quick fix, man’. But that just enhances the problem. Sure you’ll feel better for a short time, but you always need more and faster. The real cure is to get it out of your system. I propose going cold turkey. “If you’re riding high on that cheap credit hog, don’t look for a cure from the hair of the dog.”
More importantly, the economy is not about money, but instead about resources. The government does not create resources, simply re-allocates them. The real question is whether people are the best at deciding what’s best for themselves, or are other people best at deciding at how people should spend their own money. And actually now that I put it in those terms, it seems obvious that there should have been a third reason: freedom.
