The Fiscal Stimulus: Ben's take

Okay, everyone, it's time for Ben to get on his economic soapbox.  Buckle up!

This past week I've have at least 5 conversations with friends and family about the stimulus package that just passed through congress and will be signed in to law by Obama tomorrow or Tuesday.  At the insistence of my good friend Brittany, I'm posting my thoughts on here for everyone to take a look at, and I'd love to hear back from everyone about what your thoughts are.

First off, I believe that, in theory, when unemployment is high the government can effectively spend money to improve economic conditions.  Essentially that's what fiscal stimulus is: government expenditure designed to jump start a slow economy by either creating jobs directly or giving people money to spend which will increase demand and hence create jobs.  A stimulus is usually either a increase in government spending or a reduction of taxes or both.  In this case, it's both.

Now, the small amount of research that I've read on whether this actually works in practice is very mixed.  Some studies find benefits from fiscal stimulus, some find no effect, and some find that it can actually hurt the economy.  The fact of the matter is, we don't really know how well it works, or under which conditions it will work.  The trouble is that there is no control group for a stimulus, so when you look at a historical event (e.g. the Depression) you can't really know what would have happened had you not increased government spending.  So determining this stuff using actual data turns out to be quite difficult.  But, the fact that the results are so completely inconclusive suggests to me that either (1) fiscal stimulus has a very small effect or (2) the effect is extremely dependent on the circumstances, and we don't understand this relationship.  These two options make me very worried that we are gambling nearly $800 billion on a package that either (1) won't do much or (2) has the possibility of really hurting the economy.

Now, let's suppose that a good fiscal stimulus actually would help to jump start the economy.  What would this "good" stimulus look like?  In my opinion, first and foremost it would restore confidence that the world is not going to fall apart.  When individuals and business have confidence, they are more willing to spend and invest, and that's what makes things start ticking again.  So, if they believe that the stimulus bill is going to save the world, there is a self-fulfilling prophecy effect where no matter what the bill actually accomplishes, the economy begins to recover as people have more confidence.  Unfortunately, the government has basically no control over this aspect of a stimulus package.

The tax cuts in a good stimulus package would be focused on those who are most hurt by the economic downturn.  In this way you get more bang for your buck, since you are helping out the very people who are being dragged down by the bad times.  So, for example, you could give a tax break to individuals who have been laid off and wish to return to school, or perhaps to families who have lost their homes to foreclosure.  A fair portion of the 2009 stimulus includes these types of tax cuts.  It also has some dumb ones.  One example is that it includes a tax break for anyone who buys a car in 2009.  If people are considering buying a car, they are probably doing okay economically (not great, perhaps, but surviving).  So this is focused on the wrong group.  Also, it's going to put a lot more cars on the road, which is certainly not what the nation needs.  Lastly, it's a direct subsidy to car producers, when we would be a lot better off letting a few car companies fail.  I know that if you work for GM you probably feel differently than me about that last sentence, but the economic reality is that we have too many auto makers, and subsidizing them forces a deadweight loss on the economy.  Why not let them file for bankruptcy, reorganize into a productive company, and help any who are unemployed get more schooling or find other jobs?

Lastly, the spending portion of a good stimulus bill would be on investments that pass a cost-benefit analysis.  Just like any company, the government should not spend its money on projects that will not pay off in the future.  We could hire one group of people to dig holes and another group of people to fill those holes in.  We could even hire both groups to run around digging as many holes as possible.  But unless those holes actually start producing something useful, all we'll do is provide temporary relief to the hole-diggers (via wages), and end up with a bunch of debt and a lot of useless holes.  If, however, the money is spent on projects that increase productivity, then the future economy is also better off, resulting in more future tax revenue so the debt can be repaid.  Here's a quick example of the wrong type of project from the current stimulus:  The bill provisions a bunch of money to be spent specifically on building new schools and refurbishing old ones.  On the surface this sounds like a good idea, and undoubtedly some building and refurbishing is a good idea.  But as far as I have read, the quality of the physical school building has little effect on the quality of education the students receive.  A better idea would be to use a bunch of money to raise teacher salaries significantly.  This would stimulate the economy, since current teachers would spend more money, and at the same time it would attract high-quality individuals to the teaching profession, which has been shown to help students.  

Here's a link that has a breakdown of all of the spending and tax cuts that the bill contains.  It's a really long list.  As I glance over it, I see a lot of projects that might be good ones, some that I'm not so sure about, and some that I think are bad.  But what really worries me is that there is no way that Congress has had the time to really analyze each of these projects to be sure they pass a basic cost-benefit test.  I think that a lot of this money is going to be spent just digging holes.

To summarize, I've got two big problems with the stimulus bill:  1) It's a lot of money to gamble with when there's no real proof that it will work.  2) Even if it would work, I don't think that congress is capable of passing a bill that will meet the requirements to be the kind of stimulus that stimulates.  Not because Congressmen are dumb or evil, but just because the politics won't allow them to do so.  I just have no faith that Congress can actually spend $789 billion dollars both quickly and properly.  The two are mutually exclusive when politics are involved.

So, what would I do if I ruled the world?  I'd make the bill much smaller, and target only a few specific areas that I knew I could help with.  With the rest of the money, I'd use a portion to permanently eliminate the corporate tax, which would instantly provide an incentive for foreign companies to invest in the U.S. and domestic companies to expand operations.  Then I'd find someone a lot smarter than I am, and give them all of my resources with the charge to unfreeze financial markets so that investment can start flowing again.

In other words, I'm against the stimulus package.  But if the government mails me a check, I'll cash it.  :)