The Stimulus Failed, (Part 3), Do you want your grandchildren to pay for your walking bridge?

TWO RIVERS BRIDGE: Opening nears.

On the Arkansas Times Blog this morning Max Brantley posted some words of Paul Krugman that lamented that President Obama may be considering cutting back on federal government stimulus efforts and may even cut present government spending. I think this would be a prudent action because the “broken window” theory has never worked.

Using stimulus funds to help build a walking bridge in Little Rock may look nicer than a broken window but the principle is still the same and it has never worked in the past, so why should it work now. Brian Riedl of the Heritage Foundation shows in an article I posted below both that the stimulus has failed and why it has failed.

Paul Krugman grows wearier of President Obama’s move to the right, particularly recent pronouncements on the budget.

One striking example of this rightward shift came in last weekend’s presidential address, in which Mr. Obama had this to say about the economics of the budget: “Government has to start living within its means, just like families do. We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs.” 

That’s three of the right’s favorite economic fallacies in just two sentences. No, the government shouldn’t budget the way families do; on the contrary, trying to balance the budget in times of economic distress is a recipe for deepening the slump. Spending cuts right now wouldn’t “put the economy on sounder footing.” They would reduce growth and raise unemployment. And last but not least, businesses aren’t holding back because they lack confidence in government policies; they’re holding back because they don’t have enough customers — a problem that would be made worse, not better, by short-term spending cuts.

People just don’t understand how wasteful government can be and how giving government more control of our lives destroys much of the freedom that we should have. This series on the stimulus demostrates these points. This whole series started because of a post I did on July 6, 2011 about an post in the Arkansas Times Blog.

On July 6, 2011 on the Arkansas Times Blog I posted concerning the walking bridge in Little Rock that stimulus funds help build:

Tim Griffin spoke in Central Arkansas recently at a townhall meeting and mentioned that a couple of million of stimulus money went to build the walking bridge in Little Rock that will be opening this summer. Then he went on to show how it was silly for our government to try to stimulate the economy with our national credit card.
Steve Chapman rightly noted in his article “Stimulus to Nowhere” noted:

The federal government took out loans that it will have to cover with future tax increases … so states don’t have to. It’s like paying your Visa bill with your MasterCard.

The person using the username “Arkansas Panic Fan” responded:

Bridge = good stuff for Central Arkansas. Not sure why it is a bad thing. It is your money at work here being used for your benefit. I applaud this type of government activity. This is the type of project and progress you can see, touch, smell, hear.

That being said, Saline Republican, is this a waste of your money? You can use it as you wish.

__________________________________

Yes it has been a waste of money and it has not helped the economy at all.

Why the Stimulus Failed
Fiscal policy cannot exnihilate new demand

BRIAN RIEDL

Conservatives have correctly declared President Obama’s $787 billion “stimulus” a flop. In a January report, White House economists predicted the bill would create (not merely save) 3.3 million jobs. Since then, 2.8 million jobs have been lost, pushing unemployment toward 10 percent.

Yet few have explained correctly why the stimulus failed. By blaming the slow pace of stimulus spending (even though it’s ahead of schedule), many conservatives have accepted the premise that government spending stimulates the economy. Their thinking implies that we should have spent much more by now.

History proves otherwise. In 1939, after a doubling of federal spending failed to relieve the Great Depression, Treasury Secretary Henry Morgenthau said that “we have tried spending money. We are spending more than we have ever spent before and it does not work. . . . After eight years of this administration we have just as much unemployment as when we started . . . and an enormous debt to boot!” Japan made the same mistake in the 1990s (building the largest government debt in the industrial world), and the United States is making it today.

This repeated failure has nothing to do with the pace or type of spending. Rather, the problem is found in the oft-repeated Keynesian myth that deficit spending “injects new dollars into the economy,” thereby increasing demand and spurring economic growth. According to this theory, government spending adds money to the economy, taxes remove money, and the budget deficit represents net new dollars injected. Therefore, it scarcely matters how the dollars are spent. John Maynard Keynes famously asserted that a government program paying people to dig and then refill ditches would provide new income for those workers to spend and circulate through the economy, creating even more jobs and income. Today, lawmakers cling to estimates by Mark Zandi of Economy.com that on average, $1 in new deficit spending expands the economy by roughly $1.50.

If that were true, the record $1.6 trillion in deficit spending over the past fiscal year would have already overheated the economy. Yet despite this spending, which is equal to fully 9 percent of GDP, the economy is expected to shrink by at least 3 percent this fiscal year. If the spending constitutes an injection of “new money” into the economy, we may conclude that, without it, the economy would contract 12 percent — hardly a plausible claim.

If $1.6 trillion in deficit spending failed to slow the economy’s slide, there’s no reason to believe that adding $185 billion — the 2009 portion of the stimulus bill — will suddenly do the trick. But if budget deficits of nearly $2 trillion are insufficient stimulus, how much would be enough? $3 trillion? $4 trillion?

This is no longer a theoretical exercise. The idea that increased deficit spending can cure recessions has been tested, and it has failed. If growing the economy were as simple as expanding government spending and deficits, then Italy, France, and Germany would be the global economic kings. And there would be no reason to stop at $787 billion: Congress could guarantee unlimited prosperity by endlessly borrowing and spending trillions of dollars.

The simple reason government spending fails to end recessions is that Congress does not have a vault of money waiting to be distributed. Every dollar Congress “injects” into the economy must first be taxed or borrowed out of the economy. No new income, and therefore no new demand, is created. They are merely redistributed from one group of people to another. Congress cannot create new purchasing power out of thin air.

This is intuitively clear in the case of funding new spending with new taxes. Yet funding new spending with new borrowing is also pure redistribution, since the investors who lend Washington the money will have that much less to invest in the economy. The fact that borrowed funds (unlike taxes) must later be repaid by the government makes them no less of a zero-sum transfer today.

Even during recessions — when total production falls, leaving people with less income to spend — Congress cannot create new demand and income. Any government spending that increases production at factories and puts unemployed individuals to work will be financed by removing funds (and thus idling resources) elsewhere in the economy. This is true whether the unemployment rate is 5 percent or 50 percent.

For example, many lawmakers claim that every $1 billion in highway stimulus will create 47,576 new construction jobs. But Congress must first borrow that $1 billion out of the private economy, which will then lose a roughly equivalent number of jobs. As transportation-policy expert Ronald Utt has explained, “the only way that $1 billion of new highway spending can create 47,576 new jobs is if the $1 billion appears out of nowhere as if it were manna from heaven.” Removing water from one end of a swimming pool and dumping it in the other end will not raise the overall water level. Similarly, moving dollars from one part of the economy to the other will not expand the economy. Not even in the short run.

Consider a simpler example. Under normal circumstances, a family might put its $1,000 savings in a certificate of deposit at the local bank. The bank would then lend that $1,000 to the local hardware store. This would have the effect of recycling that spending around the town, supporting local jobs. Now suppose that, induced by an offer of higher interest rates, the family instead buys a $1,000 government bond that funds the stimulus bill. Washington spends that $1,000 in a different town, creating jobs there instead. The stimulus bill has changed only the location of the spending.

The mistaken view of fiscal stimulus persists because we can easily see the people put to work with government funds. We don’t see the jobs that would have been created elsewhere in the economy with those same dollars had they not been lent to Washington.

In his 1848 essay “What Is Seen and What Is Not Seen,” French economist Frédéric Bastiat termed this the “broken window” fallacy, in reference to a local myth that breaking windows would stimulate the economy by creating window-repair jobs. Today, the broken-window fallacy explains why thousands of new stimulus jobs are not improving the total employment picture.

Keynesian economists counter that redistribution can increase demand if the money is transferred from savers to spenders. Yet this “idle savings” theory assumes that savings fall out of the economy, which clearly is not the case. Nearly all individuals and businesses invest their savings or put it in banks (which in turn invest it or lend it out) — so the money is still being spent somewhere in the economy. Even in this recession, with tightened lending standards, banks are performing their traditional role of intermediating between those who have savings and those who need to borrow. They are not building extensive basement vaults to hoard cash.

Since the financial system transfers savings into investment spending, the only savings that drop out of the economy are those dollars literally hoarded in mattresses and safes — and there is no evidence that this is occurring en masse. And even if individuals, businesses, and banks did distrust the financial system enough to hoard their dollars, why would they suddenly lend them to the government to finance a stimulus bill?

Once the idle-savings theory collapses, so does all the intellectual support for government spending as stimulus. If there are no idle savings to acquire, then the government is merely borrowing purchasing power from one part of the economy and moving it into another part of the economy. Washington becomes nothing more than a pricey middleman, redistributing existing demand.

Even foreign borrowing is no free lunch. Before China can lend us dollars, it must acquire them from us. This requires either attracting American investment or raising the Chinese trade surplus (and the American trade deficit). The balance of payments between America and other nations must eventually net out to zero, which means government spending funded from foreign borrowing is zero-sum.

I’ve purposely ignored the Federal Reserve, which actually can inject cash into the economy, but not in a way that constitutes stimulus. Congress can deficit-spend; Treasury can finance the deficit spending by issuing bonds; and the Federal Reserve can buy those bonds by printing money. Any economic boost is then due to the Federal Reserve’s actions, not the deficit spending — and of course the Federal Reserve will have to raise interest rates, slowing the economy again, to bring the resulting inflation under control.

If government spending doesn’t cause economic growth, what does? Growth happens when more goods and services are produced, and the only true source of this is an expanding labor force combined with high productivity. High productivity in turn requires educated and motivated workers, advanced technology, adequate infrastructure, physical capital such as factories and tools, and the rule of law.

Government spending could boost long-run productivity through investments in education and infrastructure — but only if politicians could target those investments better than the private sector would. And it turns out that politicians cannot outsmart the marketplace. Mountains of academic studies show that government spending generally reduces long-term productivity.

Furthermore, most government programs that could increase productivity don’t work fast enough to counteract a recession. Education spending cannot raise productivity until its student beneficiaries graduate and enter the work force. It can take more than a decade to build new highways and bridges.

The only policy proven to increase productivity in the short term is to lower tax rates and reduce regulation. Businesses can grow only through consistent investment and an expanding, skilled workforce. Cutting marginal tax rates promotes these conditions, by creating incentives to work, save, and invest.

It’s happened before. In 1981, President Reagan inherited an economy stagnating under the weight of 70 percent marginal income-tax rates. Under Reagan, the top rate fell to 28 percent, and the subsequent surge in investment and labor supply created the strongest 25-year economic boom in American history.

Such tax-rate reductions are superior to tax rebates designed to “put money in people’s pockets.” Rebates — like government spending — simply redistribute existing dollars. They don’t increase productivity because they don’t change incentives: No one has to work, save, or invest more to get a tax rebate. The 2001 and 2008 rebates failed because Congress borrowed money from investors and foreigners and redistributed it to families. Not surprisingly, any new personal-consumption spending was matched by corresponding declines in investment spending and net exports, and the economy remained stagnant.

If conservatives wish to provide economic leadership, they must get this argument right. The stimulus is not failing because it is too small or because too much of it is being saved. It’s failing because Congress can only redistribute existing demand, not create new demand. This recession will eventually end. The more serious, long-term danger is that President Obama’s Europeanization of the economy will bring the same slow growth, stagnant wages, job losses, high taxes, and lack of competitiveness that have plagued Western Europe, leaving the United States at an ever-growing disadvantage with Asian countries not so afflicted.

To prevent this, conservatives and free marketeers will need to promote policies that support long-term prosperity. The first step will be articulating why big government does not bring economic growth.

Mr. Riedl is a research fellow at the Heritage Foundation.

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