By David Cay Johnston
The views expressed are his own.

Every day we hear politicians and pundits say that government spending cannot lift the economy out of the worst slump since the 1930s, which is as sensible as saying that 2-1=3 or that water and flour make steak.

Those who said after President Barack Obama’s speech last week to Congress that government does not create wealth, does not create jobs and cannot stimulate the economy spoke nonsense. So do those who say that only private business creates wealth, as if any revenue going to taxes destroys wealth.

Adam Smith, who figured out market capitalism in his 1776 book “The Wealth of Nations,” could set them straight. We have plenty of equally competent economists who understand these issues today. They just do not get the attention that the news media lavish on high-profile politicians and pundits who speak with absolute certainty on matters about which their words show they know nothing.

So why are politicians and commentators who speak economic nonsense treated as sages? And why do so many journalists uncritically repeat their nonsense?

Sadly, the answer is that too few people in public life understand economics, numbers or algebra. Too few people learned, or remember, the crucial concept underlying matters of economics and finance known as accounting identities.

ACCOUNTING IDENTITIES
Accounting identities are statements that must be true no matter how you arrange the components. Thus 2+1=3 just as 3-1=2. Likewise, net worth equals assets minus liabilities just as assets equal liabilities plus net worth and profits equal revenue minus costs. But water plus flour does not equal steak.

In economics, Gross Domestic Product equals consumer spending plus government spending plus investment plus the net of exports and imports. Or in its simplest form: Spending = Output = Income.

Economics is like a circle, as Smith figured out 235 years ago. More spending by government creates jobs, whether at war plants making smart bombs, dredging ports so cargo moves efficiently or stimulating the gray matter between young ears to create productive adults. Bombs ultimately destroy value, while ports and education add value.

Now, refreshed on the bedrock economics of accounting identities, consider these statements by three prominent Republican lawmakers:

“We need to cut spending now in order to create jobs in America” — House Speaker John Boehner on the floor of the House of Representatives in July 2010. “If government spending would stimulate the economy, we’d be in the middle of a boom” — Senator Mitch McConnell in March 2011. “Government doesn’t create jobs, you do” — Representative Nan Hayworth, M.D., speaking in January to business leaders in her New York district.

None of the comments makes sense. The first violates the accounting identity that spending equals income. The second assumes that the stimulus was big enough to make up for the fall in private sector jobs, when it was less than half what accounting identity algebra showed was needed. The third is just plain nonsense.

JOBS ARE KEY
It is certainly true that jobs are key. People with jobs are taxpayers, while those without tend to become taxeaters. More wages mean more spending, which is income to others.

As John Maynard Keynes observed in 1932: “There is no possibility of balancing the budget except by increasing the national income, which is the same thing as increasing employment.”

None of this means that President Obama’s jobs package, which has no hope of becoming law, is the optimal approach. It relies, however, on sound principles.

On the other hand, creating jobs that cost more than they add in value destroys wealth. That is why a defense plant for which Senator McConnell wants to get a federal loan guarantee of $1.7 million per job makes no sense economically.

We also inhibit future wealth when we fire teachers, let roads fall apart so that truck traffic slows and repair bills rise, and ignore weakened dams whose collapse would destroy property and lives. Cutting research funds just sends researchers to China and India, along with future fortunes.

Investing in education, research and infrastructure all add to economic inputs and, in turn, increase economic outputs.

In general the market does a better job of allocating capital for investment than government does. But when the market fails, as with the unregulated insurance and bad loans that destroyed so much value in the last decade, then the only way to stop the vicious cycle of decline is for government to temporarily make up the difference through more spending. Saying otherwise is the economic equivalent of arguing that water and flour make steak.