Bush’s Stimulus Flop

January 22, 2008 • Commentary
This article appeared in The Wall Street Journal on January 22, 2008.

A reporter on Fox News recently asked, “Which presidential candidate is most qualified to turn the economy around and avoid a recession?” The quick answer is: none.

No candidate will become president soon enough to matter, and to ask the question is to presume that recessions can and should be avoided. But some business mistakes require time to be fixed. Too many houses were built in some areas, so prices have to fall to discourage more building and encourage more buying. Some banks made too many bad loans, so they need to become more cautious. Besides, if presidents really knew how to avoid recessions, why do we keep having them?

Nonetheless, President George W. Bush is now joining the election‐​year rush to “give the economy a shot in the arm.” A shot of debt, that is.

All proposals for fiscal stimulus claim to “jump‐​start” the economy by having the government borrow money from Smith and give it to Jones. Unfortunately, Smith is paid interest on that IOU, which implies a higher tax burden on somebody. That future taxpayer is, as usual, the forgotten man. All the attention is instead focused on Jones — trying to get the Jones family to spend more on what Mr. Bush alluded to as “basic necessities.”

Investors know such consumer staples are the least cyclical component of the economy. The most recession‐​prone household purchases are those that can most easily be postponed, such as new homes, cars, appliances and furniture. Increasing the generosity of unemployment benefits, home heating subsidies, and food stamps is no help to such cyclical industries.

An indiscriminate spurt in “aggregate demand” is essentially irrelevant to longer‐​term economic problems concentrated in particular industries and particular areas. Food stamps don’t buy condos in Las Vegas or new cars from Detroit. Subsidies to lower‐​income households are also very difficult for Congress to take back and therefore unlikely to prove temporary.

Extending unemployment benefits “increases the average duration of unemployment by about two weeks,” according to the Congressional Budget Office. That is certainly no stimulus. The resulting higher unemployment rate then provides an ironic rationale for more spending, which hurts rather than helps. Transfer payments discourage work. Federal purchases absorb real resources such as skilled labor, real estate and equipment that would otherwise be available at a lower cost to private business.

Why all the political emphasis on promoting a one‐​year sales push for consumer staples? Recessions never began with a drop in consumer spending, except when credit controls were imposed (1980) and when price controls collapsed (1953, 1973).

The economy was in recession from March 2001 to November 2001, but consumer spending fell in only the first and last of those months, plus September. Real consumption last November was still 3% higher than a year before — not much below the post‐​1960 average increase of 3.6%.

We are nonetheless constantly told that consumer spending is the driving force behind economic growth or recession, simply because 70% of GDP is used to finance consumption. This demand‐​side fallacy arises from focusing on uses of income rather than sources. In reality, consumption depends on income and wealth, and income and wealth depends on business. If business is profitable, personal income from work and investments will rise and that will finance consumption.

Profits are partly dependent on sales volume, but also on margins. If a business is losing money on each widget, it won’t help to sell more widgets.

Many of the most important U.S. industries sell goods and services to other businesses worldwide, not to U.S. consumers. Many purchases of low‐​income consumers are, of course, imported. A one‐​time spurt in retail sales of foreign goods may please retailers, briefly, but cannot sustain the broader economy.

Mr. Bush put great emphasis on boosting consumer and business spending “this year.” Any such temporary boost is likely to shift the timing of such purchases forward — at the expense of next year.

Economists use the phrase “political business cycle” to describe the abuse of opportunistic fiscal gimmicks (usually transfer payments) to provide a temporary boost during presidential election years. The hangover is felt during the year after presidential elections. Recessions thus began in October 1949, July 1953, August 1957, December 1969, November 1973, July 1981, and March 2001.

Alan Auerbach of the University of California at Berkeley surveyed the effectiveness of U.S. fiscal policy in 2002, concluding that “discretionary policy has had a weak overall effect on output” and that there is “little evidence these effects have provided a significant contribution to economic stabilization, if in fact they have worked in the right direction at all.”

That conclusion became slightly more controversial after the 2001 tax rebate, which turned out to be well‐​timed as a matter of luck. But the 2001 rebate, unlike today’s proposals, was not temporary. It was an advance on tax refunds resulting from the reduction of the lowest tax rate to 10% from 15% on the first few thousand of taxable income — a reduction which still cuts every taxpaying couple’s tax bill by $600. We can’t conclude that temporary rebates will “work” (temporarily boost sales of consumer staples) on the basis of evidence from a tax cut that was not temporary. And we can’t conclude that rebates confined to those with modest incomes will work on the basis of a tax cut that was granted equally to every taxpayer — including the top 20% who account for 40% of total consumption.

If it is really a good idea to “stimulate demand,” there is no reasonable doubt the Fed can do that. By contrast, it is unlikely that doling out subsidies and transfer payments to favored political constituencies will be temporary, timely or effective. It is also unlikely that one‐​year tax rebates and investment incentives could accomplish more than to make the pre‐​election statistics look a little better at the expense of 2009. That’s the next president’s problem.

Suggesting politicians should refrain from tinkering with the economy seems like standing in front of a runaway train and yelling “Stop!” Politicians on both sides of the aisle are already fighting to buy votes by “targeting” tax cuts and spending schemes toward their constituencies.

With luck, the end result may be merely wasteful and ineffective. If Fed Chairman Ben Bernanke acts on the belief that fiscal gimmicks offer a viable alternative to monetary policy, however, then putting unwarranted faith in ephemeral fiscal nostrums could end up being much worse than useless.

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