Something’s better than nothing

This is the kind of situation where you talk to 25 different economists and get 25 different answers (or, if you’re me, you talk to three. You get the idea).

An unprecedented economic downfall calls for an unprecedented fix. This much we know for sure.

But the debate about precisely what the solution should be to our financial woes has become a battlefield for political ideologies and partisanship.

Does the answer lie in tax cuts or in government expenditures? And if so, how much (or how little)?

The economic crisis has pitted the fundamental beliefs of Republicans against those of Democrats, and no one wants to budge.

So what’s the result of all this combined with a newly elected president who ran on a platform that boldly asserted transcendence of partisanship?

A mishmash. A hodgepodge. Potpourri. A gallimaufry, if you will.

Whatever you call it, it seems that in an effort to appease everyone, the stimulus fails to please anyone. By striving for broad bipartisan support, Obama undercut his own political ideology and created a stimulus that was too small and too reliant on tax cuts.

IU economics professor Edward Buffie offered this explanation: “Most estimates forecast an output gap of $2 trillion over the next two years. A stimulus package of $800 (billion) to $900 billion will probably fall well short of filling the gap – even after taking multiplier effects into account.”

In case you don’t know, the multiplier effect is the idea that for each dollar spent by the government, consumption and national income increase by more than a dollar.

How does this happen? While it’s fun to think of it as magic, in reality it is because the dollar spent does not vanish – it merely trades hands.

Contrary to popular belief, your $50 Kilroy’s tab does not consign last week’s paycheck to oblivion. Kilroy’s happily extracts your money and then re-spends it on excise fines or whatever it is that Kilroy’s purchases. This – repeated many times and on a much larger scale – produces the multiplier effect.

Because of this effect, all spending is not created equal. The dollar increase in the Gross Domestic Product per dollar spent on stimulus is highly dependent on the type of spending being done.

For instance, direct federal spending or federal funding of state and local infrastructure can produce as much as a $2.50 increase in GDP for each dollar the federal government spends. On the other hand, temporary individual tax cuts, such as Obama’s “Making Work Pay” credits that provide up to $1,000 in tax credits for families earning below $150,000, might increase the GDP by only about 50 cents.

This is because the cash-strapped states are forced to spend the money posthaste, whereas an employed citizen sitting on a cushy $150,000 salary might very well decide to save his $1,000 (or at least a large portion of it).

“Look at your favorite IU professor,” said professor Gerhard Glomm, chairperson of the IU economics department. “This has yet to really adversely affect them, especially those who are tenured. If they receive $1,000 from the government, they may use it as to pay off their car or save it to send their child to college.”

While personal saving is part of a healthy economy, it detracts from the multiplier effect because the money is not re-spent. For a stimulus package that gets the most bang for the buck, the money must continue circulating in the economy for as long as possible instead of being saved.

“The tax cuts are poorly targeted,” Glomm said. “I think that a lot of people can take care of themselves. We must help the people that need the help.”

Aside from being a noble notion, helping those in the most dire straits is also economically strategic. When faced with rising debt and unpaid bills, our nation’s jobless and impoverished have no choice but to immediately spend any government money they receive.

But the poorest 5 to 10 percent of our population does not generally decide elections. We are thus left with a tax cut provision that will be writing checks to about 95 percent of the American people (those making less than $150,000 annually). Many of those people will be more likely to put their tax cut into a savings account rather than into circulation. Frankly, that’s just a sloppy policy – not to mention ineffectual.

This is where the hodgepodgery comes in. Many economists and analysts, especially those who still cry themselves to sleep at night reminiscing about the November election, have pointed out that the package seems to be a conglomerate of pet projects and infrastructure spending sprinkled with a few tax cuts here and there.

There’s a little piece of the pie for everybody, but a lack of heavy-duty multiplier-effect-laden proposals.

Professor Eric Rasmusen of the Kelley School of Business, who recently signed a full-page ad in The New York Times opposing the stimulus, agreed.

“The various Congressional proposals so far are not stimulus bills at all,” he said. “They are a mix of special-interest tax cuts and pork-barrel spending with a general-interest layer of tax cutting on top.”

It seems that in order to please voters (as well as Congressional members) the bill has included benefits for nearly everyone.

Unfortunately, that doesn’t amount to much of an impression on the economic system.

Many of the spending provisions in the original package that could have had a significant positive impact were reduced or altered as the bill fought its way through Congress.

Paul Krugman, a Nobel Prize-winning economist and columnist for The New York Times, drew attention to the fact that some of the original bill’s strongest features (hint: ones with big multiplier effects), including aid to moneyless state governments and school construction, were drastically reduced.

The final bill agreed upon Wednesday by the two chambers of Congress eliminated $35 billion from a state fiscal stabilization fund, $16 billion from funds intended to aid in school construction, and harshly-pared down health care subsidies for the unemployed, ignoring the fierce lobbying efforts made by governors.

Also, the bill is infused with tax breaks for businesses that won’t do much good in the current economy. The large tax cut component weakens the package, Buffie said.

“This is especially true of the tax breaks for businesses,” he said. “Output is contracting because demand has collapsed and firms cannot fully utilize their existing capacity.

“Giving tax breaks to businesses does not make much sense when the underlying problem is a shortage of demand,” Buffie said.

By trying to lure Republicans onboard, Obama began with a bill that was incoherent and too small and ended with one that was much smaller and more incoherent.
Congress has whittled down the package from the $838 billion approved by the Senate and the $820 approved by the House, somehow deeming that a bill below $800 billion is “fiscally responsible,” as Senator Susan Collins, R-Maine, put it.

But the total amount shouldn’t matter as much as what the provisions are, and many of the provisions simply cannot be labeled fiscally responsible. For example, about 9 percent of the finalized bill will go toward fixing the alternative minimum tax, which was going to be addressed in a tax bill later this year. A baffled Senator Tom Harkin, D-Iowa, questioned: “Why is it in there? It has nothing to do with stimulus. It has nothing to do with recovery. This makes no sense whatsoever.”

The provisions laid out by the stimulus bill aren’t the only source of miscellany. Glomm points out that it is difficult to evaluate the stimulus because there is no clear policy goal.

“We need to strictly separate the short-run from the long-run expenditures,” he said.

Things such as medical research and investment in green technology are great uses of government expenditures, but spending in these areas is long-term and won’t kick in for several years. The extension of unemployment benefits, on the other hand, has a nearly immediate effect because the funding is going directly to people who must spend it right away.

These weak aspects of the bill are mere inefficiencies. One major fallacy committed by Congress is the inclusion of protectionist measures. Features such as the “Buy American” provision are downright counterproductive.

The cost to the economy far exceeds the value of jobs that could be saved. If you doubt this, go Google the Smoot-Hawley Tariff Act, often blamed for the severity of the Great Depression.

Not only do tariffs harm consumers by driving up prices, Glomm said they also put us at high risk for trade retaliation. Note: This is not a good time to tamper with free trade.

“The beggar-thy-neighbor policy-making that spread in late 1920s and early 1930s should provide a bleak warning,” The New York Times’ editorial board recently wrote.

We need a concerted effort of all the wealthy countries in the world working together, not isolationism.

For all it lacks, I must say that I believe this package is certainly better than no package at all.

“At this particular moment, with the private sector so weakened by this recession, the federal government is the only entity left with the resources to jolt our economy back to life,” Obama said in his speech Monday night.

Perhaps, but as Rasmusen said, “Whether Keynesian stimulus works is an open question in economics, but it is fairly well settled that what governments implement is not the non-political stimulus that professors recommend.”

This can certainly be seen in Obama’s stimulus bill.

But despite its watered-down end product, the bill’s enormity in size alone guarantees a boost in spending on some level, and it will provide funding – though perhaps not enough – to projects in need.

The stimulus supplies $150 billion for spending on infrastructure and, although decreased, still includes significant aid for state governments. An increase in government expenditures of this size has to make some sort of ripple. If nothing else, it will hopefully relax consumers and raise confidence in the markets.

But it isn’t going to be enough.

Reform of the housing and capital markets and encouragement for the American public could go just as far as the $789 billion. When discussing the economy, Obama must move away from the recent hyperbole that makes use of terms such as “catastrophe” and “disaster” and “doom.”

The truth is, no one really knows for sure the nature of this downturn or how to find the magical key that will unlock the door to economic prosperity.

“We can spend the money and the economy may still flounder,” Glomm said.
Nevertheless, I think the stimulus is a step in the right direction. However, it is certainly not the final solution. It needs to be paired with reforms and reassurances.