Economic Stimulus Will It Work? Maybe, Maybe Not

Economic Stimulus Plan is Not a Panacea

 

As 2009 begins, I reflect back on how the last bailout performed and reminisce about how all the money that was already wasted bailing out corporations at the expense of American taxpayers, and now it looks like more waste could be coming under the heading of an “economic stimulus plan.”  While consumer confidence might get a psychological boost in seeing that our government “does something” to ease the economic crisis, the reality is that these policies, particularly if laden with waste and special interest projects, could do more harm than good.  Let me explain why …

 

Much of the Plan is not about Stimulus

According to the Congressional Budget Office, nearly half of the proposed spending will not be pumped into the economy until after 2010, which means that the plan has little to do with stimulating the economy and more to do with increasing spending on pet projects.  That may benefit a few special interest groups, but not consumers as a whole.

 

In Theory: What the Stimulus Plan Promises

The basis for passing an economic stimulus is that it creates a “multiplier effect” – where money is injected into the economy to produce more goods and services, which require more jobs for production, which give workers more wages to spend on goods and services, which stimulate more job growth, and so on.  All of this economic activity is supposed to add up to more than the original economic stimulus, which helps the economy rebound.  At least, that is what we are told.  But, there is a flaw in that logic.

 

In Reality: It’s Just Like Water in the Bathtub

Money is not free.  To spend money, it needs to come from somewhere.  If money is taken from somewhere, it means there will be less money available “somewhere” to buy other goods and services, which requires fewer employees to produce it, which reduces workers wages, which means less is purchased, and so on.  As Dr. Laffer (creator of the “Laffer Curve”) pointed out recently, it’s like scooping water from one side of the bathtub and pouring it out on the other side, the positive effects of the stimulus will be completely offset by negative effects, and the economy is no better off.

 

The Unintended Consequences Do More Harm than Good

But, a second look at the plan shows that it is not just a mere wash of positive and negative effects.  In reality, elements of the stimulus plan attempt to redistribute income, which will leave the economy much worse off.  No one would argue that it is a good thing to take all of the income from all of the working parts of the economy (total GDP) and give it to those parts that do not work, because that would cause all of the production in the U.S. economy to cease completely.  This is another point recently echoed by Dr. Laffer.  Therefore, why would it be a good idea to take $1,000 from a productive worker and give it to someone who does not work at all?  This transfer of income, as proposed in the plan, would do more harm to the economy than good, and do this at the very time when stability is most needed.

 

We need to Eliminate any Inefficient and Irresponsible Spending

It is also possible that the plan will spend on projects (using your money) that should be fixed by someone else (using their money).  For example, funds are going to be used to help state and local government under fiscal distress.  However, the problem is one caused by bloated government budgets.  It is a travesty to bailout governments that spend beyond their means, and to do so at the expense of consumers.  Moreover, there will be no economic stimulus in bailing out these governments.  It just reinforces fiscal irresponsibility. Likewise, If your household were having financial problems, you would not expect spend your way out of the problem.  

 

There is No Stimulus in Subsidizing Already Financed Projects

Last week, I spoke to a town councilman.  He told me that his town had saved up to fund an important infrastructure project and they were finally ready to begin.  However, at the last council meeting, the suggestion was made to apply for TARP funding or rely on the stimulus plan’s infrastructure funding.  So, the town will now try to use government funding intended to stimulate the economy to pay for a project that it would have funded on its own.  Again, there is no stimulus; just a transfer of income.   

 

Keynesian Economics is No Magic Pill

While the unemployment rate of this recession has yet to peak, so far it remains lower than most recessions in modern time.  Yet, we are constantly reminded of how this recession is “the worse” since the Great Depression.  And, unlike previous economic recovery programs that focused on tax reductions as the impetus for stimulus, this recovery, like the Great Depression, calls for major spending programs to revive the economy and create 3-4 million new jobs.  However, in looking back at the New Deal years, we see that the spending programs did not bring a quick turnaround in the economy and unemployment never dipped below 20%.  This point was made in a letter printed in the Washington Post, New York Times and Roll Call and signed by 200 prominent economists.  Recovery from the Great Depression coincided with preparation for WWII.  Because the stimulus plan is large, lacks sufficient tax cuts and is not well targeted, we expect a slower economic recovery.         

 

 

Looming Deficit Poses Future Problems for Consumers

In summary, the government doesn’t spend its money better than you do.  Therefore, unless some changes in direction are made, we expect the U.S. will soon have added nearly $2 trillion dollars to the national debt from bailouts and the economic stimulus plan.  Considering that the U.S. economy produced about $14 trillion in total GDP this year, the future consequences to the economy may be high.  When the economy recovers, the growth in GDP may not be enough to cover the interest on the nation’s debt.  This will lead to higher inflation and interest rates, much like the 1970’s period of stagflation.

 

What Should Be Done?

In summary, we should not be misled into thinking that an enormous increase in government spending is good for the economy. History shows that economic cycles have come and gone without the automatic need for any economic stimulus plan.  However, if a stimulus plan is needed to give consumers an increased faith in the direction of the economy, spending plans should be modest, and targeted for big returns or immediate benefits.  For example, encouraging private investment would spur productivity and commerce, as well as produce greater multiplier effects than many other types of spending.  More importantly, tax decreases could be used as an effective way to give consumers their money back, as well as to encourage spending and boost consumer confidence. 

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3 thoughts on “Economic Stimulus Will It Work? Maybe, Maybe Not

  1. Thanks for the Email, Editor,
    I agree with the issues you are putting forward regaiding the form of Government expenditure required to flag off an economic recovery.

    You however do not clearly state how the American government is planning to spent the “stimulus monies” especially in what you imply to be the wrong way.

    What i am aware of is the Tax cuts and increased infrastructural expenditure. Is this as gross?

    Rgds,
    Phillip

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