When both financial and economic crises hit, President George W. Bush backed a $170 billion “stimulus” bill and then massive industry bail-outs—of banks, Wall Street, automakers, and the housing industry. President Obama accelerated the latter efforts while adding his own $825 billion American Recovery and Reinvestment Act in early 2009. Several smaller “stimulus” efforts costing well over $100 billion followed.
As a result, federal outlays and debts exploded. In 2008 federal red ink was “only” $479 billion. Since then Uncle Sam’s annual deficit has exceeded a trillion dollars. In addition, the Federal Reserve launched a massive “stimulus” campaign—costly bail‐outs and mortgage purchases, near zero interest rates, and two rounds of “quantitative easing.” Economist Joseph Stiglitz noted earlier this year that “Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level.”
None of these efforts have spurred economic growth. In fact, unemployment soared, hitting ten percent. The jobless rate is still over eight percent despite administration promises that it would fall below six percent by last April.
Some “stimulus” advocates blame state and local spending which, they claimed, fell. However, Edward Lazear, former chairman of the President’s Council of Economic Advisers, pointed out that while real government spending was down a little in 2010 over 2009, GDP growth rates were higher. Outlays were up in 2011 while GDP growth dropped. Lazear added: “The White House forecasts that government spending in 2012 will exceed 2011 levels by 5 percent and will be 27 percent higher than it was in 2008.”
If government could spend America to prosperity, good times would have arrived long ago.
Yet President Obama won’t stop. Last year he proposed another “jobs” initiative, the $447 billion “American Jobs Act” grab‐bag, which included subsidies for state and local governments. Literally millions of jobs, most of them in or for government, would be created, he claimed, by Washington borrowing more money America doesn’t have for government projects America can’t afford.
In July the New York Times published an unintentionally hilarious editorial contending that “Mr. Obama’s big mistake was to turn prematurely from the need for stimulus to a focus on cutting the budget.”
The Times apparently missed the $1.2 trillion deficit the administration will run this year. Or the president’s future budget submission: the Congressional Budget Office estimated that the president’s program would raise accumulated red ink over the next decade from $3 trillion to an astonishing $6.4 trillion. Where is the radical budget‐cutting in Washington.
A similar debate is occurring in Europe, with the contest presented as “austerity” versus “growth.” Yet many of the nations which practiced austerity have grown the fastest. Germany remains the continent’s powerhouse even though its post‐2008 stimulus was far less relative to its GDP than in the U.S. and other European states. Both Germany and Sweden enjoyed strong growth as they brought their budgets into closer balance.
My Cato Institute colleague Michael Tanner also pointed to the Baltic states of Estonia, Latvia, and Lithuania. All cut government outlays; all are growing. Canada and Switzerland similarly rejected profligacy as policy. He wrote: “All these countries are following the successful examples set by other nations such as Chile, Ireland, and New Zealand in the 1980s and ‘90s, and Slovakia from 2000 to 2003.”
In contrast, Portugal’s Finance Minister, Vitor Gaspar, warned the New York Times: “My country definitely provides a cautionary tale that shows that, in some instances, short‐run expansionary policies can be counterproductive.” He added: “There are some limitations to the intuitions from Keynes.” In fact, Portugal may be headed for a second European Union bail‐out.
Economic growth requires good spending, not more spending. After all, Washington could pay every American $10,000 to dig a hole in his or her neighbor’s yard and then another $10,000 to fill it in. It would be a ludicrous policy, yet Keynes argued that the unemployed would be better off if paid by the government to “dig holes in the ground.”
Most jobs bills are little different than paying people to dig holes. Politics, not economics, dominates. University of Chicago economist Raghuram Rajan admitted “When people say austerity is not the answer, fine, if you have great things to spend on, let us know what they are.” The ARRA ignited a lobbying frenzy, turning the measure into a Christmas tree for legislators to hang long desired projects and favored social spending. By one estimate the bill “created” jobs at an average cost of $278,000. The cost of some individual jobs exceeded a million dollars each.
Tom Evslin, who coordinated Vermont’s federal “stimulus” money, concluded that “much of the money ended up continuing bloated programs rather than providing a transition to a sustainable future.” He pointed to broadband and energy programs, where private investment “dried up as companies waited to see if they could build with taxpayer money. Entrepreneurial effort turned from innovation to grant‐grabbing.” Last September the New York Times reported that critics “say the money has gone to areas where it is not needed, to promote broadband where it already exists and for industrial parks designed to attract business and jobs that may never materialize.”
The heart of the case for government spending as stimulus is the fabled Keynesian “multiplier.” John Maynard Keynes claimed that after government spent a dollar others would spend it again and again, “multiplying” the economic effect. Pay me $20,000 to dig and fill two holes, and I will buy things. In turn, my sellers will buy things. And on it will go.
It is a dubious theory. First, it costs government money to tax and spend. Observed Harvard economist Robert Barro, “it is wrong now to think that added government spending is free.”
Second, the theory presumes that government will use the resources productively. Explained Barro: The argument “implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out.” Economist Dwight Lee made a similar point: “increased real aggregate demand is the result, not the cause, of an increasingly productive and prosperous economy.”
Nor is there compelling evidence of a large positive multiplier. Economists John Cogan and John Taylor reviewed the ARRA and concluded: “despite the large size of the program, the dollar volume of additional government purchases that it has generated has been negligible.” Their earlier research debunked federal attempts to stimulate the economy during the 1970s: government stimulus programs “did not work then and they are not working now.” Also criticizing the ARRA was a recent study from the Phoenix Center, which noted: “We are now several years on, and many economists and policymakers are beginning to doubt the ability of government spending and monetary policy to effectively correct our current employment problems.”
Robert Barro reviewed the experience of World War I, World War II, the Korean War, and the Vietnam War, and came up with a multiplier of 0.8, which means that government outlays actually “lowered components of GDP aside from military purchases.” He and Charles Redlick figured that military spending generated a multiplier greater than one only with very high levels of unemployment, well above current levels.
In extending his analysis to peacetime, Barro reported as multiplier “a number insignificantly different from zero.” Since the 1960s government spending has been tied to the business cycle; he and Redlick believed “that government spending increased in response to growing GDP, rather than the reverse.” He figured that roughly $900 billion in federal “stimulus” spending from ARRA probably resulted in only $600 billion in increased growth, a bad deal by any measure. He and Redlick concluded: “spending stimulus programs will likely raise GDP by less than the increase in government spending.”
A 2009 IMF study of economic research suggested a multiplier in the range of 0.3 to 1.8, with some variation based on country size. In a paper for the National Bureau of Economic Research, Valerie Ramey of the University of California (San Diego) reviewed the economic literature, which suggested that the multiplier probably was between .8 and 1.5, and almost certainly was between .5 and 2.0.
However, she personally reached far more negative findings: “For the most part, it appears that a rise in government spending does not stimulate private spending; most estimates suggest that it significantly lowers private spending. These results imply that the government spending multiplier is below unity. Adjusting the implied multiplier for increases in tax rates has only a small effect. The results imply a multiplier on total GDP of around 0.5.”
Similar was the result of a 2011 study from the Phoenix Center for Advanced Legal & Economic Public Policy Studies. The four authors found: “government spending has zero effect on private‐sector job creation. This result is consistent with the apparent impotence of huge federal government spending increases in recent times aimed at reducing unemployment.”
Historical experience argues against government’s ability to “stimulate” the economy. Franklin Delano Roosevelt was elected president during the Great Depression. He spent wildly and the economy recovered a bit, only to sink again. In 1939 Treasury Secretary Henry Morgenthau complained that “After eight years of this administration we have just as much unemployment as when we started … and an enormous debt to boot!”
In fact, UCLA economists Harold L. Cole and Lee E. Ohanian blamed the New Deal for prolonging the Great Depression by seven years. Cole explained that Roosevelt produced a program “allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies.” Argued Cole: “the recovery would have been very rapid had the government not intervened.” Ohanian believed that “a relapse isn’t likely unless lawmakers gum up a recovery with ill‐conceived stimulus policies.” But that’s just what the president is trying to do.
Moreover, contrary to myth, World War II did not end the Depression. As economist Robert Higgs has well‐documented, war‐time prosperity was an illusion, with non‐government GDP growth slowing. “During the war years the economy operated essentially as a command economy,” he wrote, with few “normal measures of macroeconomic performance.” After all, the government conscripted 16 million men into uniform and directed much of America’s economic activity into war production. There was little change in total national wealth. Arthur Herman, a visiting scholar at the American Enterprise Institute, pointed out that “Even with rising wages, they had to put up with rationing and very limited choice in consumer goods.”
Ironically, it was the end of this wartime “stimulus spending”—which Herman figured at $3 trillion in today’s dollars—which led to economic growth. At the time people feared that Washington slashing arms production and demobilizing military personnel would lead to another depression. However, he observed, “private investment came roaring back, triggering steady economic growth that pushed the U.S. into a new ear, as the most prosperous society in history.” Added Herman, “the biggest trigger to growth turns out to have been a sharp rise in private capital investment, which the New Deal had slowed.”
Why is that? One reason, contended Cole and Ohanian, is that over time “the large gap between manufacturing wages and productivity that emerged during the New Deal had nearly been eliminated.” Another factor was the cut in marginal income tax rates, which topped out at 94 percent.
Moreover, Higgs cited the end of “regime uncertainty” characterized by the Roosevelt administration’s early attacks on business, which resulted in “a pervasive uncertainty among investors about the security of their property rights in their capital and its prospective returns.” Confidence returned after the war. Explained Higgs: “Sufficiently sanguine for the first time since 1929, and finally freed from government restraints on private investment for civilian purposes, investors set in motion the postwar investment boom that powered the economy’s return to sustained prosperity notwithstanding the drastic reduction of federal government spending from its extraordinarily elevated war‐time levels.” Reducing outlays is critical to return to prosperity.
Alas, the only thing that government “stimulus” stimulates is government. Valerie Ramey observed: “Increases in government spending do reduce unemployment. For all but one specification, though, it appears that all of the employment increase is from an increase in government employment, not private employment.”
Indeed, the primary beneficiaries of government “stimulus” programs are in the nation’s capital. The Washington Post headlined one article: “Stimulus is Boon for D.C. Area Contractors. The Wall Street Journal titled a story: “Washington Firms Soak Up Stimulus.”
Finally, any attempt at “stimulus” leaves a long‐term cost after any short‐term benefits have long dissipated. Observed Barro: “fiscal deficits have only a short‐run expansionary impact on growth and then become negative.” Thus, constantly increasing deficits result in “persistently low economic growth and an exploding ratio of public debt to GDP.”
For this reason even the Congressional Budget Office was skeptical of the ARRA. Over time the agency steadily reduced its estimate as to the number of jobs created and warned that the benefits were temporary. The CBO figured that the president’s program would increase GDP through 2012, but there would be no effect in 2013 and 2014 and then the impact would be negative. Last November the agency concluded that ARRA’s impact peaked in 2010, while the accumulated debt would “reduce output slightly in the long run—by between 0 and 0.2 percent after 2016.”
That is, diverting productive capital to pay off government debt will permanently reduce the GDP. Workers will earn less while paying more to finance a larger debt. Warned CBO: “Budget deficits that grow faster than the economy ultimately become unsustainable. As the government attempts to finance its interest payments by issuing more debt, the rise in deficits accelerates. That, in turn, leads to a vicious circle in which the government issues ever‐larger amounts of debt in order to pay ever‐higher interest charges. In the end, the costs of serving the debt outstrip the economic resources available for financing those expenditures.”
The economy could use a real stimulus, not massive government spending. The primary economic challenge is too much government spending. Rajan argued for treating “the crisis as a wake‐up call and move to fix all that has been papered over in the last few decades.” According to a recent IMF review of 66 adjustments programs, structural reforms were most likely to succeed. The best programs included real budget reductions and were not based on raising taxes.
Economists Kenneth Rogoff of Harvard University and Carmen Reinhart of the Peterson Institute figured that when debt approaches 90 percent of GDP growth tends to slow. Noted columnist Robert Samuelson: “Since 1800, major countries have experienced 26 episodes when government debt has reached 90 percent of GDP for at least five years, they find in a study done with Vincent Reinhart of Morgan Stanley. Periods of slower economic growth typically lasted two decades.” Counting Treasury‐Social Security borrowing, the U.S. already is over 100 percent.
Thus, argued independent investor Jeff Carter: “In the long term cutting government spending is good for economic growth. Competition for growth capital between private industry and government ends. Government gets out of the business of running things and private industry takes over. Private companies are always more efficient and responsive than government.”
There is much that should go into a comprehensive economic reform program. Suggested Harold Cole and Lee Ohanian: “reforms should include very specific plans that update banking regulations and address a manufacturing sector in which several large industries—including autos and steel—are no longer internationally competitive. Tax reform that broadens rather than narrows the tax base and that increases incentives to work, save and invest is also needed. We must also confront an educational system that fails many of its constituents.”
The point is not that every regulation is bad, but even those which are not nevertheless often are badly designed, implemented, and/or enforced. Unfortunately, with ObamaCare as his administration’s centerpiece, President Obama has become the Regulatory President. Yet, emphasized Robert Barro, the economy needs “incentives for people and businesses to invest, produce and work.”
President Barack Obama would prefer to talk about anything other than the economy. However, he ran on the economy in 2008. He can’t run away from it in 2012. The best way to stimulate the economy would be to shrink government, reduce outlays and debt, lower marginal tax rates, and streamline regulations. This economic “stimulus” program really would stimulate.