Just like everywhere around the globe, the Croatian government has decided to embark on a spending spree in an apparent attempt to boost domestic aggregate demand.
According to the web portal www.business.hr, 15 billion HRK will be allocated through public – private enterprise programs to rebuild Croatia’s ailing public infrastructure. This plan would rebuild and build new schools, hospitals and other infrastructure. It is not mentioned which firms will get a shot in the arm through this spending plan and in what parts of the country, we just know that it will happen.
The problem with all of these stimulus programs is its financing and distributive effects. Usually, when entrepreneurs get a business idea, they have to figure out the cost of doing business. The business (whatever it may be) can be financed through equity or debt. The price of the borrowed funds are determined through the supply and demand of the same on the market. Assuming a certain level of generated savings in the economy and the term structure of thereof, capital projects of this magnitude are brought about a reduction in consumption as resources are freed up and diverted in these lengthy endeavors. But, this is not the case.
These projects are funded through government borrowing, or taxes or inflation. Depending on the source of the financing, each intrusion by the government will have a negative side effect on the broader economy. It is true that certain companies will generate accounting profits in the medium term, depending on the accounting techniques they employ or a certain tax shield they might enjoy in the form of deferred taxes. But, will these projects really lift the welfare of the country in general?
It will create employment for the now unemployed construction workers as well as all the indirect employment in other industries. But cash flow generation probably won’t occur, nor will the required rate of return on capital that the free market would require. This plan will create a short boost of the so-called GDP aggregate and nothing more. The funds appropriated to these projects will be syphoned off from other parts of the productive economy and wasted on these that we don’t need. Even if the government can calculate the cost of these projects (using different valuation techniques) the same way the market would calculate from them, the funds are just not there to support these projects in the present environment. Austrian economist Ludwig von Mises showed that the inability of government to micro manage the economy comes from its innate inability of economic calculation and the price system. How does fixing a battered wall on a government building lift the wealth of the economy?
The same way I supposedly decide to smash a window and than repair it. My bashing of the window provides demand for the window maker, which in turn buys a new suit with that new money, the tailor receiving that money buys a loaf of bread from the baker and so fort, lifting the national income. French economist Frederic Bastiat already solved this “broken window” fallacy a while back and it shows that while the window maker does receive the income, the society, however, in aggregate, is suit or a par of shoes or a wrist watch less off.
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