This is a sample or model of how you might construct and organize Analytical Essays for ECON 408. Note that the essay has a descriptive title. The body of the essay is divided into sections, but there are no question numbers -- the questions are answered in a narrative fashion, rather than direct responses to number 1, number 2, etc. Note also how sources are cited. You do not, of course, have to follow this model exactly (after all, the content of your actual essay will differ from the Sample) but you would be well-advised to adhere to its general principles.

Government Budgets and National Income:

Testing the Theories of Defunct Economists

            In the four years 2003-2006, the United States has had the four largest federal government budget deficits in the history of the country; the deficit in 2006 was $423 billion (Economic Report of the President). Politicians and economists have expressed concerns about the about the effects of such large budget deficits on interest rates, investment, and ultimately, national economic growth. This essay examines the impact of budget deficits in the context of the theories of defunct economists Eve Smythe, Thomas Mann, and Ricky Ricardo. The essay presents the theories of each of these defunct economists, considers which of these is most influential today, and uses modern evidence to test which of the theories is correct.

The Theories of Defunct Economists

            In the late 1700s and early 1800s, several differing theories of the relationship between government finance and economic growth were popular. These theories were to a large extent mutually exclusive.

            In 1764, Thomas Mann published Englands National Finnance, which represented the views of the Commercialist school of thought. The Commercialists argued that nations with government budget deficits would experience more rapid economic growth than would nations with government budget surpluses, because the government spending that created the budget deficit would encourage consumers to spend more. The increased spending would cause producers to increase production, boosting national income. As Mann argued, “Every occasion of budgetary shortfall engenders an occasion of financial increase and general prosperity” (Englands National Finnance, p. 4). As a result, Mann and the Commercialists called on government to maintain a high rate of spending: “It is incumbent upon the national authorities to always and everywhere expend a sum greater than the sum of national revenue” (Englands National Finnance, p. 22).

            Eve Smyth published An Inquiry Into the Nature and Causes of the Debt of Nations in 1775. Smyth’s work is largely forgotten today, but it was modestly influential for a year or two after its publication. (Smyth’s claims that later writers borrowed many of her ideas have fallen on deaf ears.) Smyth’s work can be seen as an attempt to refute the Commercialist position. Smyth argued that government budget deficits would retard economic growth while government budget surpluses would encourage economic growth. Smyth wrote in The Debt of Nations (Book I, Chapter 3, Paragraph 14) that “every saving by the government that diminishes the government expenditure or augments the government taxable receipts promotes the government wealth.” Smyth argued that a government budget deficit would raise the price of capital stock, so that capitalists would employ fewer labourers. With fewer labourers employed, the nation’s productive output would decline. Smyth thus called upon the government to raise taxes and reduce its spending: “government should so far as practicable extract every bit of revenue from capitalists and in that way maintain its own budgetary surplus” (The Debt of Nations, Book I, Chapter 3, Paragraph 17).  Smyth noted that “it is not from the benevolence of the butcher, the brewer, or the baker that the government obtains its revenue” (The Debt of Nations, Book I, Chapter 3, Paragraph 30) so that government should be prepared to use force to get capitalists to pay what properly belonged to the government. The famous example of government raids on a pin factory (The Debt of Nations, Book I, Chapter 3, Paragraph 1) illustrates the extent to which Smyth believed that government should do whatever was necessary to avoid a budget deficit.

            Ricky Ricardo’s 1805 masterpiece, Principles of Government Spending and Taxation, maintained that Mann’s and Smyth’s emphasis on the government budget was misplaced. Ricardo argued that the government’s budget deficit or surplus was irrelevant to determining the wealth of a nation. As Ricardo put it (Principles of Government Spending and Taxation, Chapter 4, Paragraph 1), “It is of no concern whether governmental expenditures exceed government receipts or the contrary.” The implication of this position is that government, consumers, capitalists, and landowners should pay no attention to whether their actions increased or decreased the government budget surplus. As he wrote in Principles of Government Spending and Taxation (Chapter 4, Paragraph 13), “government should weigh the budgetary overage or shortfall not at all in its deliberations and actions.” Unfortunately, Ricardo offered no evidence or examples to support his position.

The Influence of Defunct Economists

            The continuing influence of the defunct economists can be seen in discussions of the current U.S. budget deficit. The 2006 U.S. budget deficit of $423 billion, the largest in U.S. history, has sparked much excitement in the traditional media. Many news reports apparently adhere to the position of Eve Smyth. For example, a January 28, 2007 report in the Boston Globe states that “the large budget deficit is believed to a harbinger of recession later in the year” (http://www.bostonglobe.com/madeupstory). An earlier report in the New York Times (January 4, 2007) similarly suggested that the budget deficit was “an indication of coming hardship for the U.S. economy” (http://nytimes.com/nosuchthing). A November 17, 2006 editorial in the Wall Street Journal called for “decreases in the current U.S. budget deficit as a means of increasing economic growth” (http://www.wsjournal.com/examplecitation). All of these reports suggest that Eve Smyth’s arguments in The Debt of Nations have a powerful influence on opinionmakers in the U.S. today.

The Evidence

            The positions of Mann, Smyth, and Ricardo are largely mutually exclusive. That is, it is not possible for all of them to be correct at the same time. To test which of the three theories is correct, we will look at two sorts of modern evidence: economic growth in countries with budget deficits and budget surpluses, and budget surpluses or deficits in countries with high and low economic growth.

            Thomas Mann’s theory predicts that countries with larger budget deficits will have faster economic growth than will countries will large budget surpluses. Eve Smyth’s theory predicts that countries with larger budget deficits will have slower economic growth than will countries with large budget surpluses. Ricky Ricardo’s theory predicts that there will be no relationship between budget deficits or surpluses and economic growth; some countries with large budget deficits will have rapid economic growth, but so will some countries with large budget surpluses.

            Table 1 shows the countries with the largest government budget surpluses (as a percentage of GDP) and the corresponding real rates of GDP growth in those countries (data are drawn from NationMaster.com). Table 1 also shows the countries with the largest government budget deficits and the real rates of GDP growth in those countries. Rates of GDP growth are for the preceding one-year period.

            Among the 20 countries included in this sample, the three highest rates of growth are for countries with large budget surpluses. Four of the countries with large budget deficits have real growth rates of 3 percent or less; only two of the countries with large budget surpluses have real growth rates less than 3 percent. The (unweighted) mean growth rate of the countries with large budget surpluses is 6.2 percent, significantly higher than the (unweighted) mean growth rate of 3.7 percent in countries with large budget deficits.

            The evidence in Table 1 thus suggests that a budget surplus is more conducive to economic growth than is a budget deficit. The evidence in Table 1 thus supports Eve Smyth’s theory and is inconsistent with the theory of Thomas Mann.

            Table 2 also presents evidence on the relationship between budget deficit or surplus and economic growth, but does so from a different perspective. Table 2 shows the countries with the greatest real GDP growth and their corresponding budget deficit or surplus; the table also shows the countries with the slowest real GDP growth rates and their corresponding budget deficit or surplus.

            As is shown in Table 2, all of the countries with rapid economic growth have government budget surpluses. In contrast, six of the ten countries with the slowest economic growth have budget deficits. Zimbabwe, the country with the largest budget deficit among this sample, has the slowest economic growth. This evidence is consistent with Smyth’s theory that budget surpluses increase economic growth while budget deficits retard economic growth. The evidence is inconsistent with both Mann’s and Ricardo’s theories. The one country that does not fit neatly with Smyth’s prediction is Saint Kitts and Nevis. With the largest budget surplus among the countries in this sample, Smyth’s theory would predict that Saint Kitts and Nevis should enjoy rapid economic growth, rather than the very slow economic growth that it in fact does experience.

            Overall, then, the evidence from Table 1 and Table 2 clearly are consistent with Smyth’s theory and are inconsistent with Mann’s and Ricardo’s theories. Mann’s prediction that a budget deficit would increase economic growth is not supported by the evidence. Ricardo’s prediction that budget deficits and surpluses likewise is not supported, because Table 2 in particular shows that there is a clear and strong connection between government budget balance and economic growth.

Evidence, Influence, and Conclusion

            The evidence thus suggests that, at least among these three defunct economists, Eve Smyth most nearly correctly predicted the relationship between government budget deficits and economic growth. It is not surprising, therefore, that Smyth’s theory of the “visible hand” is the most influential theory today. Evidence from the world today suggests that Smyth’s observation that “it is not from the benevolence of the butcher, the brewer, or the baker that the government obtains its revenue” (The Debt of Nations, Book I, Chapter 3, Paragraph 30) was correct. Indeed, we must appeal “not to their self-interest but to the force of government” (The Debt of Nations, Book I, Chapter 3, Paragraph 31) to obtain government revenue. The force of government, by increasing government tax revenue, “acts as an iron fist to promote the public welfare” (The Debt of Nations, Book I, Chapter 3, Paragraph 13). The iron fist theory of government spending and taxation is as applicable today as it was in Smyth’s own time.