Prosperity through cutting government spending

David Henderson:

We often hear that big cuts in government spending over a short period of time are a bad idea. The argument against big cuts, typically made by Keynesian economists, is twofold. First, large cuts in government spending, with no offsetting tax cuts, will lead to a large drop in aggregate demand for goods and services, thus causing a recession or even a depression. Second, with a major shift in demand (fewer government goods and services and more private ones), the economy would experience a wrenching readjustment, during which many people would become unemployed, and the economy would slow down. 

But if such claims were true, wouldn’t history confirm them? And wouldn’t the decline in the economy be large when the government cuts spending a lot? That’s certainly what the late Keynesian economist Paul Samuelson thought. Well, Samuelson was wrong, and not just wrong, but spectacularly wrong. 

In a 2010 study for the Mercatus Center at George Mason University, I examined the four years from 1944, the peak of World War II spending, to 1948. Over those years, the U.S. government cut spending from a high of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948, a drop of over 35 percentage points of GNP. The result was an astonishing boom. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But between 1945 and 1948, it reached its peak at only 3.9 percent in 1946. From September 1945 to December 1948, the average unemployment rate was 3.5 percent. 

Most of the policies that Samuelson had feared actually happened, and in spades. Price controls were eliminated. Not only was the federal budget deficit decreased, but also, in 1947, the budget surplus was over 5 percent of GNP. Demobilization happened big-time. Between 1945 and 1947, when the postwar transition was complete, the number of people in the armed forces fell by 10.5 million. Civilian employment by the armed forces fell by 1.8 million, and military-related employment in industry fell off the cliff from 11.0 million to 0.8 million. As demobilization proceeded, optimistic employers in the private sector scooped up millions of the soldiers, sailors, and others who had been displaced from the armed forces and from military industries.

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This article published by the Hoover Institute supports a history I have discussed before.  Besides cutting spending, the Republican Congress also cut taxes.  If you look at what is happening in the red states, they follow a similar patter, while blue state budgets continue to drag down the economy with a tax and spend model.