Why the Obama Stimulus Plan Must Fail

This article appeared in Forbes on July 21, 2009.

As we now cross the six-month mark in the Obama presidency, it is becoming ever more difficult for the president to distance himself from a long string of lackluster economic reports. Exhibit A are disappointing unemployment numbers to which the president consciously did not refer to in his July 11 speech to the country. But the basic position is this: Congress passed the President's $787 billion package this past February with no Republican support in the House and only three Republican defections in the Senate. At the time, brave presidential words promised that this package could create some 4 million new jobs, so that the unemployment rate would top at around 8%. Alas, there are 2.6 million fewer jobs today than when the bill passed, with an unemployment rate of 9.5%, which is still inching upward.

Something is amiss. Naturally, the president now counsels patience, insisting that improvement will come in the long run. No such luck. Stimulus bills are rotten to the core. To be sure, they are supposed to, as the president insists, pump dollars into the hands of cash-starved Americans whose spending will jump start the economy. But we don't need to wait for empirical reminders to realize that this claim is, theoretically, dead on arrival. Ex nihil nihilo: out of nothing, nothing comes. It is as though corporations could work their way to greater wealth by making stock dividends to their shareholders. One might as well increase the size of a cherry pie by increasing the number of slices.

The key theoretical point is that the U.S. economy will only grow if the government steps will help increase its productive capacity on net. Stimulus programs of both the Bush and Obama variety flunk that test at the design stage. One component of these programs is to funnel cash in the form of one-time rebates or tax cuts to particular individuals. But that money has to come from somewhere else. If it consists of new dollars, it reduces, by dilution, the value of the existing stocks of money held by others.

So why then aren't these transfers a wash? For some economists, usually of the Harvard/MIT stripe, the argument rests on the view that those individuals who receive stimulus dollars are more likely to save than to spend them than the folks who end up with a smaller fraction of the social pie. The two responses to this claim are first, false, and second, so what?

First, it is exceedingly difficult to guess whether individuals of limited means will use a one-time stimulus to pay off credit card debt, save for major expenditures or spend on current consumption. Second, no one knows what the optimal division is between spending and saving in the first place. The whole point of market rates of interest is to give signals so private individuals can decide where to place their dollars. Both investment and consumption are important. The difficulty with a stimulus program is that the uncertainty and administrative costs from the transfer program leaves less of both on the table. In the end, the cash transfers are worse than just spinning wheels. They cannot expand the economic pie.

Nor are the defects in the cash transfers offset by the various specific spending programs, many of which are repackaged pork from earlier days. Once again, the iron law of scarcity offers no respite to the unwary. Every time the government asserts control over scarce resources, fewer resources remain available to the private sector.

Ideally, we should like to organize spending so that the marginal dollar spent in each sector has equal value. But that won't happen if the government proposals are uninformed efforts to spur industrial policy. The president takes pride that he is spending on clean energy sources. But he never explains why he gives to certain energy companies and not to others. In the end, the likely result will be that the unwise government programs will drive out better private ones. On net, shrinking productivity translates into fewer jobs, which explains the spike in unemployment rates.

To these first two strikes, we should add a third. The president and the Democrats are now in control of Congress. The Republicans are in disarray. So we have to face these grim prospects: continued record deficits, a huge nationalization of health care, the imposition of heavy carbon taxes, an insane Employee Free Choice Act and higher tax rates and special assessments in 2011 on the most productive individuals of our society.

Today's investors have figured out that tomorrow does not look so rosy. So they are holding back on investment until the storm passes. No new investment, no new jobs. As libertarians well know, each new extension of government power should be examined under a presumption of error. By that standard, the president's stimulus package — indeed his entire legislative program — should be scrapped.