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George Soros is back in the news telling Germany who to bail out this week. Soros is especially sore at Germans for promoting austerity, so it’s a great time to ask: does austerity grow an economy?

Why do we care? Investors want to know whether austerity is good or bad for an economy; whether it’s likely to boost growth or to hasten a recession. And for voters, it’s important to know whether it’s time for more, or less, austerity.

First we want to be sure what we’re even talking about. The word “austerity” is often used to describe two things: either reducing government spending, or raising taxes. These, of course, are opposites: lower spending means fewer resources used by the government, and higher taxes means more. What the two ideas have in common is the question: should we hand fewer resources to government?

Like Aesop’s frog-eating scorpion, Keynesian vote-buyers diligently dig up reasons why vote-buying is good for us all. One of their rallying cries is that we cannot “cut our way to prosperity.” Like all propaganda, such claims are misleading — austerity isn’t about “cutting.” It’s about transferring. Specifically, transferring control over productive resources from bureaucrats to individuals and companies.

Let’s have a look at the vote-buyers’ arguments. Since their goal here is to prove why vote-buying is good for us all, their pet idea against austerity is that government spending creates a “multiplier.” So one dollar of government spending creates, say, two dollars of value. Which would be nice (like unicorns, perpetual motion, and free ice cream forever). And it would mean the Soviet Union’s collapse remains an economic mystery, seeing as it was all shot-through with that productive multiplier.

More precisely, Bob Murphy has nicely demolished this supposed multiplier. In a nutshell, whatever "multiplier" might exist is precisely cancelled by the "negative multiplier" since the resources came from somewhere. If you give one dollar to the government you spend one dollar less at the restaurant. Both dollars had a “multiplier” in opposite directions. They canceled.

So much for the free ice cream.

But, of course, it gets worse: we have great reasons to expect a negative multiplier. That is, government takes a dollar and turns it into, say, 80 cents. Or maybe a nickel. Why? Because governments are very good at wasting resources.

Let's stop and think what an economy actually is — the "microfoundations" as they say. Production doesn't fall out of the sky, like a cargo cult. Rather, production is made up of resources — factories, raw materials, workers and entrepreneurs, concrete, and steel. These things are combined to yield consumption goods, investment goods, or else they’re saved for later. Meaning there are only 3 things you can do with a productive resource — consume it, invest it, or save it for later.

Meanwhile, there are only three categories of people to do any of this consuming, investing, or saving for later. Those are individuals, companies, or governments.

So the question of whether austerity is good or bad is simply a question of whether governments are better custodians of resources. Will government make more productive investments, will they save more prudently, than individuals and companies?

Unless you live under a rock, you already know the answer: governments are astoundingly wasteful. Government “investments” belong in The Onion, and “prudent savings” by governments are in a faraway exotic land.

So if government is a relatively poor steward of resources, it automatically follows that every resource wrenched from the doomed clutches of government makes us richer. Sure, we’ll get fewer wars, less corporate welfare, and less research on robo-squirrels (some of us would pay to lose those particular “investments”). And, instead, those resources go to more productive and prudent investment by people who are spending their own money, who have competent and motivated oversight of how those resources are used.

The core claim of austerity — that resources should be shifted from governments to individuals and companies — is true so long as governments are bad custodians of productive resources. As long as that productivity gap continues — which might be a while — it will remain true that austerity will grow, not shrink, an economy. And so we can merrily liberate our economy, by cutting the government on our way to prosperity.

Image source: iStockphoto.