Sunday, June 14, 2009

The Fallacy of Stimulus

Like many people, last year’s collapse of the financial system led me to take another look at the economics I learned in college. In earlier posts, I’ve mused about the notion that we’re all missing something—that there’s some subtlety that it takes a Keynes or a Krugman to figure out.

I’ve changed my mind. This plan is ridiculous, and it takes nothing more than common sense and experience to see that.

Over the last six months, the Obama administration and Congress have poured trillions into the economy in an attempt to avert more serious recession. The idea was that Roosevelt didn’t ‘spend enough, fast enough,’ and that was a major contributor to the Great Depression. My gut and my study of history told me that was wrong—it's pretty obvious that Roosevelt's tax policies prolonged the Great Depression, and only World War II pulled us out. Moreover, I’ve worked in government, and with government, so I was immediately suspicious of the concept of “shovel ready” projects. No one—no one—plans, designs, and approves a project knowing they don’t have money for it. Oh, sure, you can find the one exception, but even money says that “exception” is actually a project that was funded that lost its funding.

The crux of the problem came home last week when Vice President Biden made a comment that the government would have to reinvigorate its efforts to get the stimulus money spent—that only some $40 billion or so of the $787 billion authorized had actually been spent. For me, that was the alarm bell that finally made me realize all those (mostly conservative) pundits were right—most of this “stimulus” won’t be spent until 2010, well after it could do any good. In fact, it will be spent just in time to help with the 2010 elections, and if the incumbents are lucky, just before too much money in the system sparks inflation. (Although the President has a plan to curb inflation—he will be raising taxes in 2010, by letting the Bush tax cuts expire.)

The simple truth is that governments cannot spend billions extra in a matter of weeks. The system just doesn’t work that way. Even after the money is authorized by Congress, it takes months just to get it obligated on a contract. It takes more months to get it expended—and until it’s expended, it isn’t stimulating anything. And, while “months” is really, really fast when you’re building something, it’s far too slow to have any relevance to the business cycle.

I don’t know if the Keynesians just don’t understand the reality of bureaucracies, or if their faith in theory has simply blinded them to it. I do know that common sense tells me there are two ways to get money into the economy rapidly: 1) cut taxes, 2) hand out cash.

It has become popular to argue that this collapse has “proven” supply-side economics doesn’t work. I have yet to see anyone actually make that case with anything other than partisan talking points, and I don’t think they can. Instead, they rely on the populist argument that cutting income tax only helps the rich—because half of Americans pay no income tax at all. Um, okay—I thought we were talking economic stimulus? When did we switch to social policy? We can certainly have that discussion, but conflating the two issues suggests the redistributors have a not-so-hidden agenda.

But, if you’re worried about getting money into everyone’s hands, it isn’t just income tax that can be cut. Slash the corporate income tax, and 1) companies can cut prices; which 2) makes goods more affordable; which 3) increases demand; which 4) increases the need for labor. It isn’t just shareholders who benefit—everyone does. But, of course, that’s not popular to say in these populist times. (And shareholders benefiting just creates stimulus, too--because they either spend or invest their profit, and if they invest it, that just gives it to someone else to spend. Stimulus all around.)

This leads us to consider option two: handing out cash. That will certainly get money into everyone’s pockets, but there’s an obvious problem—for the 50% of Americans who pay no income tax, you’ve simply taken capital out of the system, because you have to borrow that money to pay them off. (And, please, spare me the argument that these folks pay Social Security taxes—they will get that back fivefold when they retire, and again, we aren't talking social policy here.) So, you may get a very short term stimulus from the demand, but you’re choking the engine that will ultimately create more jobs.

Finally, that brings us to the ultimate Keynesian argument—that deficit spending is okay in a recession, because the capital you’re borrowing isn’t being used, anyway. While that might be the case in some recessions, it certainly is not the case now—the major argument the populists are making against the banks is that they aren’t lending. Of course, they aren’t lending because they’re scared to death about what's next and what's really on their balance sheets, so they are keeping higher reserves. How, exactly, does government stripping those reserves out of the system improve confidence? It doesn’t, of course.

Which is why I am, just now, starting to worry about stagflation.