Whither Military Keynesianism?

From The Hill:

"A top defense and aerospace industry trade organization is pressing House Speaker John Boehner (R-Ohio) to resist deep Pentagon budget cuts as officials grapple with the nation’s troubled finances.

In a letter to Boehner, Aerospace Industries Association (AIA) President Marion Blakey argues substantial Defense budgets cuts would spawn new job losses and further damage the already injured economy.

Capitol Hill and defense industry sources tell The Hill that negotiators have discussed national security spending cuts as large as $700 billion over a decade; that is almost twice as much as the $400 billion in security cuts by 2023 that President Obama has called for.

'Deeply cutting defense during these tough economic times could make our nation’s fiscal and broader economic situation even worse,' Blakey wrote. 'Major cuts to defense would create further layoffs and great uncertainty for them and their families and undercut economic gains.'"

Blakey conjures up an interesting argument: give my constituents more money or run the risk of blighting the economy. Now given all the ridicule with which to bespatter Ms. Blakey, who is an example par excellence of the category of human being who lobbies on behalf of the industry that he or she has previously been in charge of regulating, epitomizing the worst elements of the infamous Washington "revolving door", I nevertheless won't discount her last-ditch argument merely because she has a financial stake in the acceptance of her conclusion. To do so would be to commit the vested interest fallacy. Her economic allegations are more than enough cannon fodder.

The premise from which Blakey's proceeds should be a familiar one. It is a conclusion of military Keynesianism, a variant of Keynesianism which holds, among other things, that increasing military spending can contribute to economic growth and that increasing such spending is advisable during or in anticipation of recessions as part of a policy of increasing aggregate demand to hedge against recessions.

It should be no surprise that military Keynesianism commits the same errors as standard Keynesianism.

First off, it underappreciates the opportunity cost of government spending. As a reminder, opportunity cost, as I employ it, refers to the value of the next-most-preferred alternative use of a set of resources.

Suppose a $100 billion military budget is sufficient to protect the nation from foreign aggression. Fine. Military Keynesians, at least under certain conditions, would have the government expand this budget by an unspecified amount, say another $100 billion, on the grounds that doing so will increase economic growth. Well, since $100 billion is scarce (money is a scarce resource), $100 billion spent by the government means $100 billion denied to the private sector, where it could have been used for consumption and investment. This is known as the crowding-out effect.

Moreover, we have every reason to expect, in advance, that the opportunity cost of allowing the government to spend $100 billion is greater than the opportunity cost of allowing the private sector to spend $100 billion because of incentives. Within the private sector, the prospect of profits or losses incentivizes prudent consumption and investment habits. No such similar prospect exists within the "public sector", where the survival of a firm is not necessarily contingent upon performance in satisfying demand and where the assurance of revenue (e.g., taxation) erodes the incentive for wise decision-making.

Th crowding-out effect occurs as well if the spending is made possible by debt financing. Hence, if the government borrows money in order to expand the military and subsidize the defense industry, the borrowing represents in increase in the demand for credit which raises interest rates. Rising interest rates mean more expensive credit for private sector economic agents, thus crowding them out of the credit market.

The cyclical prescriptions of military Keynesianism are derived from the notions that recessions are caused by a lack of aggregate demand and that recessions are to be avoided. The former is misleading and the latter is false altogether. Recessions begin, in the words of economist Jesus Huerta de Soto, after "the pace of credit expansion unbacked by real saving stops accelerating". Central banks incite faux economic expansions by increasing the supply of credit in the absence of an increase in the supply of savings, i.e., monetary inflation. This causes interest rates to fall, which in turn causes the quantity of credit demanded by firms to rise. As firms acquire more credit, they begin to spend more money, principally to acquire additional factors of production, capital goods in particular, with which to produce more goods for customers. This process bids up both capital goods and consumer goods (price inflation, in other words), as the additional money introduced into the economy is spent and as factors are withdrawn from lower order stages of production (consumer goods) to higher order stages of production (capital goods).

As price inflation rises, monetary authorities typically reduce the supply of credit in order to halt it, which causes a rise in interest rates. This sparks the recession. Interest rates rise (even past pre-credit expansion levels due to increases by lenders as a hedge against price inflation and the increase in demand for credit by firms in anticipation of even higher future interest rates), credit becomes scarce, firms operating with higher order production stages get priced out of the credit market and become credit starved, leaving them with incomplete investment undertakings staffed with labour, land, and capital goods that must be "liquidated" or sold so as to cut losses and avoid insolvency. This process of liquidation is called a recession.

Recessions however are to be treated as visits to the dentist - painful but necessary - not as painful and unnecessary events. The liquidation process must occur because too many investment projects are incomplete and too costly to continue (due to rising interest rates). In addition, the high prices of goods, especially capital goods, is an effect of a dis-coordinating decision by the monetary authorities to expand the supply of credit without an equal expansion of savings, hence those prices must be allowed to fall so as to allow for the proper coordination of economic agents. Military Keynesianism, therefore, is powerless to correct the mal-adjustments produced by such credit expansion, for the solution is an economic contraction, not additional spending.

I draw attention to this issue because more than enough Republicans in Congress, despite their apparently shallow demands to cut spending, have demonstrated their unwillingness to cut the budget of the Defense Department. They claim to oppose Keynesianism, but will they show clemency towards this version of Keynesianism because of the military element? I won't hold my breath, as was once said.