We’ve Had Enough Government ‘Stimulation’
After three years and $4 trillion in combined deficit spending, unemployment remains stubbornly high and the economy sluggish. That people are still asking what the government can do to stimulate the economy is mind-boggling.
That the Keynesian-inspired deficit spending binge did create jobs isn’t in question. The real question is whether it created any net jobs after all the negative effects of the spending and debt are taken into account. How many private-sector jobs were lost or not created in the first place because of the resources diverted to the government for its job creation? How many jobs are being lost or not created because of increased uncertainty in the business community over future tax increases and other detrimental government policies?
Don’t expect the disciples of interventionist government to attempt an answer to those questions any time soon. It has simply become gospel in some quarters that massive deficit spending is necessary to get the economy back on its feet.
The idea that government spending can “make up for” a slow-down in private economic activity has already been discredited by the historical record—including the Great Depression and Japan’s recent “lost decade.”
Our own history offers evidence that reducing the government’s footprint on the private sector is the better way to get the economy going.
Take for example, the “Not-So-Great Depression” of 1920-21. Cato Institute scholar Jim Powell notes that President Warren G. Harding inherited from his predecessor Woodrow Wilson “a post-World War I depression that was almost as severe, from peak to trough, as the Great Contraction from 1929 to 1933 that FDR would later inherit.” Instead of resorting to deficit spending to “stimulate” the economy, taxes and government spending were cut. The economy took off.
Similarly, fears at the end of World War II that demobilization would result in double-digit unemployment when the troops returned home were unrealized. Instead, spending was dramatically reduced, economic controls were lifted, and the returning troops were successfully reintegrated into the economy.
Therefore, the focus of policymakers in Washington should be on fostering long-term economic growth instead of futilely trying to jump-start the economy with costly short-term government spending sprees. In order to reignite economic growth and job creation, the federal government should enact dramatic cuts in government spending, eliminate burdensome regulations, and scuttle restrictions on foreign trade.
The budgetary reality is that policymakers today have no choice but to drastically reduce spending if we are to head off the looming fiscal train wreck. Stimulus proponents generally recognize that our fiscal path is unsustainable, but they argue that the current debt binge is nonetheless critical to an economic recovery.
There’s no more evidence for this belief than there is for the existence of the tooth fairy.
Not only has Washington’s profligacy left us worse off, our children now face the prospect of reduced living standards and crushing debt.
This article originally appeared in a PolicyMic debate between the Cato Institute’s Tad DeHaven and Demos senior fellow Lew Daly. Check out Daly’s piece here.
Paul Krugman Meets E.T.
I’ve poked fun at Paul Krugman for his views on health care and British fiscal policy, and I’ve semi-defended him about unemployment subsidies and housing bubbles.
Now it’s time for some more mockery.
Back in 2001, Paul Krugman received some much-deserved criticism for stating that the 9/11 terrorist attacks would be stimulative for the economy.
He committed the “broken-window” fallacy, explained more than 150 years ago by a famous French economist, Frederic Bastiat.
Breaking a window at the local bakery, Bastiat explained, might generate business for the town glazier, but only at the expense of some other merchant, like a tailor, who would have benefited if the baker didn’t have to spend money on a new window.
In other words, the destruction of wealth is not good for an economy. At best, it makes us poorer and then shifts how current income is allocated. This is why Bastiat wrote (perhaps predicting the emergence of Krugman):
There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.
But we have to give Krugman credit for a bizarre form of ideological consistency. He is willing to advocate bigger government, no matter how sloppy the reasoning or how quirky the rationale.
His latest outburst was to say on CNN how wonderful it would be for the economy if the people of earth mistakenly thought we were on the verge of an alien invasion, which would lead to lots of military spending.
He even cited an episode of Twilight Zone to justify his assertions. I’m surprised he didn’t also mention the 1996 film, Independence Day.
As I wrote in a previous blog post, this is one of those moments when your only response is to say “wow.” This is even worse than when Keynesians assert that it would be stimulative to pay people to dig holes and fill them in again.
For those who want more info on why government spending does not boost the economy in the short run, here’s my video on Keynesian economics.
And if you want to know why government spending does not boost the economy in the long run, here’s a video looking at some empirical evidence about economic performance and the size of the public sector.
Debt Deal to Slow the Economy?
The Washington Post reports that spending cuts in the budget deal threaten to slow the economy. The article quotes a number of economists who seem to harbor a rather extreme Keynesian bias in their thinking.
The deal would cut discretionary spending by just $21 billion in 2012, or just 0.6 percent of total federal spending that year. And that’s after federal spending has risen 22 percent since 2008 ($2.98 trillion in 2008 to about $3.63 trillion this year). Even if you believe that government spending helps the economy, it seems rather bizarre to claim that a 0.6 percent retrenchment after a 22 percent increase would hurt.
The other thing to note about these spending-cut worries is that, for Keynesians, it is the total amount of deficit spending that is the amount of economic “stimulus.” We’ve had deficit spending of $459 billion in fiscal 2008, $1.4 trillion in fiscal 2009, $1.3 trillion in fiscal 2010, and $1.4 trillion in fiscal 2011. That is a colossal amount of “stimulus.”
In fiscal 2012, we’ve got even more “stimulus” coming, with a projected federal deficit of about $1.1 trillion, per the CBO March baseline. So a spending cut of $21 billion will reduce the giant Keynesian stimulus in 2012 by just 2 percent. And yet the Washington Post says that this will “endanger the anemic economic recovery,” according to “many economists.”
Those “many economists” who believe in Keynesianism might be more believable if their theories hadn’t so obviously failed in recent years. Despite the enormous deficit-spending “stimulus” of recent years shown in the chart, U.S. unemployment remains stuck at high levels and the recovery is the slowest since World War II by numerous measures. (See cites in my testimony here.)
Biggest stimulus, slowest recovery. Keynesianism isn’t working.
Basic Economics for Financial Journalists and Other Dummies
While driving home last night, I had the miserable experience of listening to a financial journalist being interviewed about the anemic growth numbers that were just released.
I wasn’t unhappy because the interview was biased to the left. From what I could tell, both the host and the guest were straight shooters. Indeed, they spent some time speculating that the economy’s weak performance was bad news for Obama.
What irked me was the implicit Keynesian thinking in the interview. Both of them kept talking about how the economy would have been weaker in the absence of government spending, and they fretted that “austerity” in Washington could further slow the economy in the future.
This was especially frustrating for me since I’ve spent years trying to get people to understand that money doesn’t disappear if it’s not spent by government. I repeatedly explain that less government means more money left in the private sector, where it is more likely to create jobs and generate wealth.
In recent years, though, I’ve begun to realize that many people are accidentally sympathetic to the Keynesian government-spending-is-stimulus approach. They mistakenly think the theory makes sense because they look at GDP, which measures how national income is spent. They’d be much less prone to shoddy analysis if they instead focused on how national income is earned.
This should be at least somewhat intuitive, because we all understand that economic growth occurs when there is an increase in things that make up national income, such as wages, small business income, and corporate profits.
But as I listened to the interview, I began to wonder whether more people would understand if I used the example of a household.
Let’s illustrate by imagining a middle-class household with $50,000 of expenses and $50,000 of income. I’m just making up numbers, so I’m not pretending this is an “average” household, but that doesn’t matter for this analysis anyway.
Expenses Income
Mortgage $15,000 Wages $40,000
Utilities $10,000 Bank Interest $1,000
Food $5,000 Rental Income $8,000
Taxes $10,000 Dividends $1,000
Clothing $2,000
Health Care $3,000
Other $5,000
The analogy isn’t perfect, of course, but think of this household as being the economy. In this simplified example, the household’s expenses are akin to the way the government measures GDP. It shows how income is allocated. But instead of measuring how much national income goes to categories such as consumption, investment, and government spending, we’re showing how much household income goes to things like housing, food, and utilities.
The income side of the household, as you might expect, is like the government’s national income calculations. But instead of looking at broad measures of things such wages, small business income, and corporate profits, we’re narrowing our focus to one household’s income.
Now let’s modify this example to understand why Keynesian economics doesn’t make sense. Assume that expenses suddenly jumped for our household by $5,000.
Maybe the family has moved to a bigger house. Maybe they’ve decided to eat steak every night. But since I’m a cranky libertarian, let’s assume Obama has imposed a European-style 20 percent VAT and the tax burden has increased.
Faced with this higher expense, the household — especially in the long run — will have to reduce other spending. Let’s assume that the income side has stayed the same but that household expenses now look like this.
Expenses
Mortgage $15,000
Utilities $9,000 (down by $1,000)
Food $4,000 (down by $1,000)
Taxes $15,000 (up by $5,000)
Clothing $2,000
Health Care $3,000
Other $2,000 (down by $3,000)
Now let’s return to where we started and imagine how a financial journalist, applying the same approach used for GDP analysis, would cover a news report about this household’s budget.
This journalist would tell us that the household’s total spending stayed steady thanks to a big increase in tax payments, which compensated for falling demand for utilities, food, and other spending.
From a household perspective, we instinctively recoil from this kind of sloppy analysis. Indeed, we probably are thinking, “Spending for other categories — things that actually make my life better — are down because the tax burden increased!!!”
But this is exactly how we should be reacting when financial journalists (and other dummies) tell us that government outlays are helping to prop up total spending in the economy.
The moral of the story is that government is capable of redistributing how national income is spent, but it isn’t a vehicle for increasing national income. Indeed, the academic evidence clearly shows the opposite to be true.
Let’s conclude by briefly explaining how journalists and others should be looking at economic numbers. And the household analogy, once again, will be quite helpful.
It’s presumably obvious that higher income is the best thing for our hypothetical family. A new job, a raise, better investments, an increase in rental income. Any or all of these developments would be welcome because they mean higher living standards and a better life. In other words, more household spending is a natural consequence of more income.
Similarly, the best thing for the economy is more national income. More wages, higher profits, increased small business income. Any or all of these developments would be welcome because we would have more money to spend as we see fit to enjoy a better life. This higher spending would then show up in the data as higher GDP, but the key thing to understand is that the increase in GDP is a natural result of more national income.
Simply stated, national income is the horse and GDP is the cart. This video elaborates on this topic, and watching it may be more enjoyable than reading my analysis.
Friday Links
- “PBS used to ask, ‘If not PBS, then who?’ The answer now is: HBO, Bravo, Discovery, History, History International, Science, Planet Green, Sundance, Military, C-SPAN 1/2/3 and many more.”
- “The fiscal problem that is destroying U.S. economic confidence is not the fiscal balance, however. It is the level of government expenditures relative to GDP.”
- “The Pentagon’s first cyber security strategy… builds on national hysteria about threats to cybersecurity, the latest bogeyman to justify our bloated national security state.”
- “How ‘secure’ do our homes remain if police, armed with no warrant, can pound on doors at will and, on hearing sounds indicative of things moving, forcibly enter and search for evidence of unlawful activity?”
- National debt is driving the U.S. toward a double-dip recession:
How’s that Housing Stimulus Working Out for You?
Yesterday Case-Shiller released their monthly housing price index. Surprise, it fell by 4.2% in the first quarter of 2011. I’ve been predicting a decline of about 6% over the course of 2011 (might need to adjust that). Of course, this should come as no surprise. We’ve spent the last couple of years trying to re-create the bubble, with little success. While there’s been a home-buyer tax credit, the largest stimulus has been extremely cheap credit on the part of the Federal Reserve. The problem with all these subsidies is they ignore the fact that eventually the housing market will come back to fundamentals. And those fundamentals are demographics and income. You cannot over long periods of time sustain house price increases without increases in incomes. Loose credit only gets you so far. Prices have already fallen enough to pretty much wipe out the entire value of the home-buyer tax credit.
Even worse than putting off the inevitable correction, subsidies that maintain prices above construction costs result in additional supply being added to an already glutted market. While housing starts are near historic lows – they are still positive. And worse, they are higher in the very markets in which we don’t want more building. That permitting activity is twice as high in Phoenix as in San Diego, despite being of similar size, illustrates the perverse incentives of trying to re-inflate the bubble via demand subsides. In supply-constrained markets you simply maintain prices at unaffordable levels – San Diego is still 54% above its 2000 price level – while in easy-to-build markets you add to the glut – prices in Phoenix are now back to 2000 levels.
House prices were always going to find their “true” bottom. The question was simply: did we want to get there right away, or drag out the process? Washington chose the course of dragging out the process, at considerable cost. I believe dragging out the process has only further spooked potential buyers. Any buyer today has to suspect that further price declines are possible. We need to get to the point where the only direction is up. We aren’t there yet. Policymakers continue to ignore the basics of supply and demand. Unfortunately the rest of us pay the price for their doing so.
Deloitte Survey: Concerns about Government
A Deloitte Growth Enterprise Services survey of 527 executives at mid-market companies (annual revenues of between $50 million and $1 billion) found “tempered optimism” that the economic recovery will continue. However, the survey also found significant concern over government fiscal and regulatory policies.
A whopping 50 percent cited federal, state, and local debt as the greatest obstacle to U.S. growth in the coming year. Lack of consumer confidence (39 percent) and rising health care costs (33 percent) came in second and third. Lest anyone construe the executives’ concern about government debt as implied support for tax increases, high tax rates came in fourth at 30 percent. Government austerity, which can include tax increases, and infrastructure needs came in at 15 and 9 percent, respectively.
When asked to choose up to three items that represent their company’s main obstacle to growth, only 21 percent cited government budget cuts. I’m frankly surprised that the figure isn’t higher considering that a number of these companies probably “do business” with government. Increased regulatory compliance was only a tick higher at 22 percent. Health care costs came in third at 30 percent, and uncertain economic outlook was first at 41 percent. I would pin that uncertainty on government policies. It is likely that a substantial number of the respondents would agree given other survey results.
Reducing corporate tax rates (33 percent) was the clear winner when the executives were asked to choose up to two measures by the U.S. government that would most help mid-size businesses grow in the next year. Keeping interest rates low (32 percent) was close behind, followed by rolling back health care reform (23 percent). Keynesian measures that are popular in the White House, supporting increased infrastructure investment and stimulating private consumption, came in at 19 percent and 14 percent, respectively.
Finally, many, if not the majority, of respondents expect regulatory costs to increase next year, particularly in the area of health care reform. Respondents expect the president’s Affordable Care Act to sharply increase costs (33 percent) or slightly increase costs (33 percent). A majority (56 percent) expect tax compliance costs to increase. A near majority (49 percent) expect both economic and occupational health & safety regulatory costs to increase.
In sum, the good news is that optimism is on the rise in the business community. The bad news is that the heavy hand of government is still a dark cloud hovering over the recovery.
Bernanke’s Soft-Core Keynesianism Is Even Worse than the Nonsensical Analysis of Hard-Core Keynesians
Earlier this week, the Washington Post predictably gave some publicity to the Keynesian analysis of Mark Zandi, even though his track record is worse than a sports analyst who every year predicts a Super Bowl for the Detroit Lions. The story also cited similar predictions by the politically connected folks at Goldman Sachs.
Zandi, an architect of the 2009 stimulus package who has advised both political parties, predicts that the GOP package would reduce economic growth by 0.5 percentage points this year, and by 0.2 percentage points in 2012, resulting in 700,000 fewer jobs by the end of next year. His report comes on the heels of a similar analysis last week by the investment bank Goldman Sachs, which predicted that the Republican spending cuts would cause even greater damage to the economy, slowing growth by as much as 2 percentage points in the second and third quarters of this year.
Republicans understandably wanted to discredit this analysis. But rather than expose Zandi’s laughably inaccurate track record, they asked the Chairman of the Federal Reserve, Ben Bernanke, for his assessment. But this is like asking Alex Rodriguez to comment on Derek Jeter’s prediction that the Yankees will win the World Series.
Not surprisingly, as reported by McClatchy, Bernanke endorsed the notion that spending cuts (actually, just tiny reductions in planned increases) would be “contractionary.”
Bernanke was asked repeatedly about GOP proposals to trim anywhere from $60 billion to $100 billion in government spending during the current fiscal year, which ends Sept. 30. These cuts would do little to bring down long-term budget deficits but would slow the economic recovery, he cautioned. “That would be ‘contractionary’ to some extent,” Bernanke said, projecting that “several tenths” of a percentage point would be shaved off of growth, and it would mean fewer jobs. …While Democrats got what they wanted out of Bernanke with that answer, he frowned on some of their projections that the spending cuts that are being debated could reduce growth by a full 2 percentage points.
Since he is not a fool, Bernanke was careful not to embrace the absurd predictions made by Zandi and Goldman Sachs. But that’s merely a difference of degree. Bernanke’s embrace of Keynesian economics is disgraceful because he should know better. And his endorsement of deficit reduction (at least in the long run) is stained by crocodile tears since Bernanke supported bailouts and endorsed Obama’s failed stimulus.
But while Bernanke is not a fool, I can’t say the same thing about Republicans. Bernanke has made clear that he either believes in the perpetual-motion machine of Keynesianism, or he’s willing to endorse Keynesian policies to curry favor with the White House. Republicans should be exposing these flaws, not treating Bernanke likes he’s some sort of Oracle.
Economic Slack and Inflation
While listening to NPR this morning, I was subjected to yet another economist claiming that we cannot have inflation in an environment of such high economic slack. Setting aside the fact that perhaps this economist missed the 1970s, this is a vital question to examine, because it is the foundation of so much of Bernanke and the Federal Reserve’s current thinking. That is, the notion that inflation is always and everywhere the result of an over-heating, or excess demand, economy.
One of the measures commonly followed by the Fed, and others of the slack-restrains-inflation school, is the measure of capacity utilization rate. Setting aside some of the problems with this measure, are increases in capacity utilization associated with increasing inflation, as would be suggested by the slack-restraint school? It turns out not. Since 1967, when the data series begins, the correlation between capacity utilization and inflation, as measured by the consumer price index (CPI), has been negative. That is, as more and more industrial and economic resources have been brought into use, inflation has actually fallen, rather than risen (as would be predicted). A negative correlation also implies that low or falling capacity utilization does not mean low inflation.
Now what is positively correlated with inflation is the growth in the money supply. The chart below shows annual changes in both CPI and M2. Even just eye-balling the chart, one can see the positive correlation, which also shows up under statistical analysis.
Another question one often hears in today’s economic discussions is what would Milton Friedman say? I won’t claim to be able to channel Milton (or anyone else), but I do think the empirical evidence continues to support the conclusion that inflation is always and everywhere a monetary phenomenon.
The Consumer Spending Fallacy behind Keynesian Economics
I’m understandably fond of my video exposing the flaws of Keynesian stimulus theory, but I think my former intern has an excellent contribution to the debate with this new 5-minute mini-documentary.
The main insight of the mini-documentary is that Gross Domestic Product (GDP) only measures how national output is allocated between consumption, investment, and government. That’s useful information in many ways, but if we want more output, we should focus on Gross Domestic Income (GDI), which measures how national income is earned.
Focusing on GDI hopefully would lead lawmakers to consider ways of boosting employee compensation, corporate profits, small business income, and other components of national income. Focusing on GDP, by contrast, is misguided since any effort to boost consumption generally leads to less investment. This is why Keynesian policies only redistribute national income, but don’t boost overall output.
You may recognize Hiwa. She narrated a very popular video earlier this year on the nightmare of income-tax complexity.
Where are the ’60s Hippies Now that They’re Needed to Fight Keynesianism?
Keynesian economic theory is the social science version of a perpetual motion machine. It assumes that you can increase your prosperity by taking money out of your left pocket and putting it in your right pocket. Not surprisingly, nations that adopt this approach do not succeed. Deficit spending did not work for Hoover and Roosevelt is the 1930s. It did not work for Japan in the 1990s. And it hasn’t worked for Bush or Obama.
The Keynesians invariably respond by arguing that these failures simply show that politicians didn’t spend enough money. I don’t know whether to be amused or horrified, but some Keynesians even say that a war would be the best way of boosting economic growth. Here’s a blurb from a story in National Journal.
America’s economic outlook is so grim, and political solutions are so utterly absent, that only another large-scale war might be enough to lift the nation out of chronic high unemployment and slow growth, two prominent economists, a conservative and a liberal, said today. Nobelist Paul Krugman, a New York Times columnist, and Harvard’s Martin Feldstein, the former chairman of President Reagan’s Council of Economic Advisers, achieved an unnerving degree of consensus about the future during an economic forum in Washington. …Krugman and Feldstein, though often on opposite sides of the political fence on fiscal and tax policy, both appeared to share the view that political paralysis in Washington has rendered the necessary fiscal and monetary stimulus out of the question. Only a high-impact “exogenous” shock like a major war — something similar to what Krugman called the “coordinated fiscal expansion known as World War II” — would be enough to break the cycle. …Both reiterated their previously argued views that the Obama administration’s stimulus was far too small to fill the output gap.
Two additional comments. First, if Martin Feldstein’s views on this issue represent what it means to be a conservative, then I’m especially glad I’m a libertarian. Second, Alan Reynolds has a good piece eviscerating Keynesianism, including a section dealing with Krugman’s World-War-II-was-good-for-the-economy assertion.
Keynes Was Wrong on Stimulus, but the Keynesians Are Wrong on Just about Everything
Dana Milbank of the Washington Post wrote this weekend that critics of Keynesianism are somewhat akin to those who believe the earth is flat. He specifically cites the presumably malignant influence of the Cato Institute.
Keynes was right, and in this case it’s probably for the better: Keynes didn’t live to see the Republicans of 2010 portray him as some sort of Marxist revolutionary. …These men get their economic firepower from conservative think tanks such as the Cato Institute… What’s with the hate for Maynard? Perhaps these Republicans don’t realize that some of their tax-cut proposals are as “Keynesian” as Obama’s program. There’s a fierce dispute about how best to respond to the economic crisis — Tax cuts? Deficit spending? Monetary intervention? — but the argument is largely premised on the Keynesian view that government should somehow boost demand in a recession. …With so much of Keynesian theory universally embraced, Republican denunciation of him has a flat-earth feel to it. …There is an alternative to such “Keynesian experiments,” however. The government could do nothing, and let the human misery continue. By rejecting the “Keynesian playbook,” this is what Republicans are really proposing.
Milbank makes some good points, particularly when noting the hypocrisy of Republicans. Bush’s 2001 tax cuts were largely Keynesian in their design, which is one of the reasons why the economy was sluggish until the supply-side tax cuts were implemented in 2003. Bush pushed through another Keynesian package in 2008, and many GOPers on Capitol Hill often erroneously use Keynesian logic even when talking about good policies such as lower marginal tax rates.
But the thrust of Milbank’s column is wrong. He is wrong in claiming that Keynesian economics works, and he is wrong is claming that it is the only option. Regarding the first point, there is no successful example of Keynesian economics. It didn’t work for Hoover and Roosevelt in the 1930s. It didn’t work for Japan in the 1990s. It didn’t work for Bush in 2001 or 2008, and it didn’t work for Obama. The reason, as explained in this video, is that Keynesian economics seeks to transform saving into consumption. But a recession or depression exists when national income is falling. Shifting how some of that income is used does not solve the problem.
This is why free market policies are the best response to an economic downturn. Lower marginal tax rates. Reductions in the burden of government spending. Eliminating needless regulations and red tape. Getting rid of trade barriers. These are the policies that work when the economy is weak. But they’re also desirable policies when the economy is strong. In other words, there is no magic formula for dealing with a downturn. But there are policies that improve the economy’s performance, regardless of short-term economic conditions. Equally important, supporters of economic liberalization also point out that misguided government policies (especially bad monetary policy by the Federal Reserve) almost always are responsible for downturns. And wouldn’t it be better to adopt reforms that prevent downturns rather than engage in futile stimulus schemes once downturns begin?
None of this means that Keynes was a bad economist. Indeed, it’s very important to draw a distinction between Keynes, who was wrong on a couple of things, and today’s Keynesians, who are wrong about almost everything. Keynes, for instance, was an early proponent of the Laffer Curve, writing that, “Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget.”
Keynes also seemed to understand the importance of limiting the size of government. He wrote that, “25 percent taxation is about the limit of what is easily borne.” It’s not clear whether he was referring to marginal tax rates or the tax burden as a share of economic output, but in either case it obviously implies an upper limit to the size of government (especially since he did not believe in permanent deficits).
If modern Keynesians had the same insights, government policy today would not be nearly as destructive.
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