Government Accounting Is Like Lemonade Stand Economics
By JERRY L. JORDAN
Posted 01/26/2012 06:09 PM ET
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It is tempting to think that the Soviets perfected negative-value-added investment — the stuff produced is worth less than the value of the resources to produce it. However, most families have experienced this first hand.
It usually surfaces with an entrepreneurial adolescent deciding it would be a good idea to sell lemonade at the curbside to passersby
Parents, wanting to encourage the idea that working and making money is a good idea, drive around to buy the lemon, sugar, designer bottled water, cups, spoons, napkins, a sign or two, and probably a paper table cloth.
Aside from time and gas, the outing adds up to something north of $10. At the opening of business the next day, the kids find business is slow to nonexistent at $1 per cup. So, they start to learn about market demand and find that business becomes so brisk at only 10 cents per cup that they are sold out by noon, having served 70 cups of lemonade and hauled in $7.
The excited lunch-time conversation is about expanding the business. A stand across the street to catch traffic going the opposite direction; maybe one around the corner for the cross-street traffic. The kids see growing revenue; the "investors" see mounting losses.
There is a strand of economics, we'll call it the K-brand, that sees all this as worthwhile. They add together the $10 spent by the parents to back the venture and the $7 spent by the customers and conclude that an additional $17 of spending is clearly a good thing. Surely, the neighborhood economy has been stimulated.
To the family it is a loss, chalked up as a form of consumption. If this were a business enterprise it would be a write-off. In classical economics it is a "mal-investment."
In the business world, a new investment may involve building a factory, filling it with machines, hiring some people, and offering a product for sale. If after a while it becomes clear that this venture will never turn a profit, the decision is made to close it down, take a write-off against net worth and hope the experience was educational, if not profitable.
In classical economics, this "intention to invest" became a loss of economic wealth — negative-value-added. Often actual results when looking back are different than hoped for when looking forward, and business accounting adjusts for reality. Good intentions, hopes, and aspirations are not reflected in balance sheets and income statements.
All this was easy for everyone to see in agrarian economies. When the 100 bushels of seed held over from last year's crop — rather than eaten upon harvesting — are planted, the clear hope and expectation is to reap much more at the end of the growing season. That is positive-value-added investing — the value of what is produced is greater than the value of the resources needed to produce it.
But if the ravages of nature in the form of a drought, hurricane, tornado or pests almost destroys the crop and the season-end harvest is only, say, 90 bushels, then looking back at negative-value-added leaves the locals wishing they had simply eaten the 100 bushels instead of planting them. They know they are worse off even though there was an output of 90 bushels for the growing season.
But that is not how it works in government accounting. While a private business must adjust its books to reflect the losses from an intended investment that went bad, governments never do that.
When a government "invests" in, say, an airport in Johnstown, Pa., all the expenditures for labor and materials are recorded as investments and are additions to national output. Never mind that when it is later discovered that only three people a day want to fly to or from the airport, no adjustment to national wealth will reflect the folly of this "mal-investment."
If the airport had been financed by purely private, commercial enterprises, the initial expenditures would have been recorded as investment spending, but when reality struck and the entire project was written off as a total loss, the business-profit component of national output would decline. That is, a previous bad "investment" reduces, rather than augments, current national income.
In classical economics, the looking-forward intention to invest became a looking-back consumption of valuable resources. The economy was made poorer even though a lot of money was spent.
To K-brand economics, such "investing" is better done by the government because there never has to be a write-down for bad ideas. So, Japan spent a couple of decades "investing" in airports few people fly to, highways few people drive on and bullet trains that not enough people ride on. All the expenditures were recorded as investment and were additions to national output, never recognizing that the value of what was produced is less than the value of the resources needed to produce it — negative-value-added. Surely it is clear that Japan was made poorer by lots of bad "investments."
The U.S. recorded a great amount of "residential investment spending" in the central valleys of California that added to national output, only to have the houses bulldozed because there were no buyers. Subsequently, the homebuilders incurred losses, reducing business income, thus shrinking national output.
Nevertheless, the national accounts will never be revised to reflect that the "investment spending" of a few years earlier was all "mal-investment" and should have been recorded as a form of business consumption. Such "investment" actually made us poorer.
The irony of this example is the expenditures incurred to bulldoze the vacant houses is recorded as "stimulus" to the economy. Thanks for that to K-brand economics. They now want California to "invest" in a Japanese-style bullet train that is negative-value-added economics.
What's the path to restored prosperity?
The U.S. economy has been bolstered by a bubble-economy level of consumption spending financed by the creation of massive claims on future taxpayers. It breaks down like this: in 2011, consumption spending was over 71% of everything — up five percentage points from even the dot-com boom of the 1990s. Private investment spending contributed only 12% of all economic activity in 2011, down five percentage points from the average of the late 1990s.
Government purchases of goods and services were 20% of the economy, so we needed a negative contribution from international trade to get the accounts to balance at 100% of all activity. This way of reporting the government's involvement in the economy doesn't show all the borrowing by the government to make transfers to households to engage in all that consuming. (In honest accounting, government borrowing to support "mal-investment" in Solyndra and other bad ideas should be recorded as consumption; we have been made poorer.)
We know what prosperity looks like. Restoring private investment spending to a larger share of a much larger economy is essential for positive-value-added economics to raise standards of living. Real family incomes can rise on average only when productivity increases justify larger paychecks. That happens only when the goods and services produced by businesses are worth more than the resources necessary to produce them.
Even K-brand economists would not prescribe another trillion dollars of government borrowing to hire a couple million unemployed people to first dig holes and then fill them up again. Yet, the nation is already borrowing a trillion dollars to pay people to stay home — after they get back from shopping. They are being paid to produce nothing of value. That is worse than lemonade-stand economics.
Does anyone doubt that abolishing the corporate and capital gains taxes and declaring a moratorium on new regulations would ignite a private investment boom? Capital now being held abroad by corporations would pour in. Money now sitting in low-yielding financial assets would be used instead to open new businesses and expand existing ones. Millions of idle transfer receivers would become taxpayers.
It is time to reject the prosperity-stifling fiction that taxes remitted by a business are not paid by real people. Only people can pay taxes. Taxes received by governments from business enterprises are actually being paid by workers in lower after-tax wages, consumers in higher after-tax prices or investors in lower after-tax earnings.
Such taxes harm us in every dimension. They make it more costly to hire workers. They raise the prices of products to consumers. They reduce the expected returns to investing.
To tax any thing is to discourage that thing. We now tax the daylights out of prosperity. Is it any wonder that we have less of it?
• Jordan is past president of the Federal Reserve Bank of Cleveland and was a member of President Reagan's Council of Economic Advisers.
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