money-in-a-trash-can.thumbnail.jpgThere’s one big problem with Obama’s stimulus bill: the numbers don’t work. Because of the excessive reliance on tax cutting up front, the bill forgoes over 200 billion dollars of GDP, and approximately 40 billion dollars of additional lost tax revenue. This means he’s accepting an estimated additional 3/4 of a point of unemployment for no other reason that he likes tax cutting. It’s bad policy by a President who obviously hasn’t been reading Martin Wolf:

Welcome to 2009. This is a year in which the fate of the world economy will be determined, maybe for generations. Some entertain hopes that we can restore the globally unbalanced economic growth of the middle years of this decade. They are wrong. Our choice is only over what will replace it. It is between a better balanced world economy and disintegration. That choice cannot be postponed. It must be made this year.

The problem is that a banking crisis produces large falls in demand, output and employment. Worse still, it has an exponential curve of effect: half of all countries facing such a crisis have real debt increase by somewhat under 150%, but many run away and see an almost endless drain. The lesson is to reach ignition of recovery quickly, or suffer a period of lurches and reverses. Wolf warns exactly what happens next:

And to get to this point the fiscal boost must be huge. A discretionary boost of $760bn (€570bn, £520bn) or 5.3 per cent of GDP is not enough. The authors argue that “even with the application of almost unbelievably large fiscal stimuli, output will not increase enough to prevent unemployment from continuing to rise through the next two years”.

Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad. They will want their demand back. The last time this sort of thing happened – in the 1930s – the outcome was a devastating round of beggar-my-neighbour devaluations, plus protectionism. Can we be confident we can avoid such dangers? On the contrary, the danger is extreme. Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight.

In short, some form of protectionism comes into vogue. We had protectionism in the last decade: houses, defense, and health care are all industries that, because of their location, are protected from competition. China can do many things, but it can’t build a house in the suburbs of Dallas, and people don’t fly to Beijing to get their tonsils checked. This protectionism was a contributing factor to the "global imbalance" of supply and demand. Americans have been spending on consumption, and on creating financial instruments. However neither are supply. China can produce supply for consumption, but it means a burden on resource supply. While oil has collapsed, the volatility of oil markets should be a warning: all it takes is a fight in Gaza to add 10% to the cost of gasoline in the space of two weeks, and long term, both supply and sink of carbon based energy sources are constrained.

What Obama seems to have missed politically, dazzled by 80% preproval numbers – that is people don’t approve of what he is doing, they approve of him being given a chance to do something – is that liberals must push back on calling another tax cut and spend bill "Keynesian stimulus" because counter-cyclical stimulus is one of the pillars of liberalism. It is one of the key conclusions that separates modern economics from classical economics – that an economy can fall below full output, and that only government has the power to be, in such cases, the buy, seller, borrow, lender, employer, and insurer of last resort. Only government has a chance of being here when the economy craters and we are all thinking about the "eating babies case."

Krugman struck back with this blog post – and admitted that he was being generous in his estimates of the efficacy of the plan as it stands. There are increasing signs of discontent from liberal supporters of Obama, precisely because this is a core asset of the liberal idea. It is one of those ideas that Republicans, such as the Heritage Foundation, constantly seek to discredit, because they would much rather have defense spending and tax cutting as the means of redistributing buying power from the future to the present, and they promote pro-cyclical policies: make the bubbles bigger, and let the busts fall on the ordinary people to pay off with regressive taxation.

Small symbolic things, like Rick Warren being a prominent part of the inauguration, are easily forgotten in the present. But core beliefs, are more likely to produce a sense that this President is not our President, and is someone who will veer far to the right at enormous cost to the country.

Better policy and politics would have been to let the Republicans propose their business tax cuts, with some kind of justification. Because, after all, there are better and worse ways to do things, and the Republicans would, if having to drive the issue, have to select from tax changes which offer the highest demonstrated ability to generate demand inside the US, rather than simply being a hand out to those who don’t even need a hand up. Better policy would be to have fewer generic tax cuts, and a greater focus on expansion of next generation broadband, wireless umbrellas, incentives for energy efficiency, a "soot buster" program – buy back old cars in exchange for newer ones, coupons for soot filters – and money for strict enforcement of speed limits. We have a brief window where resource inflation has eased, we need to use that window to shift the global imbalance in supply and demand, or it will be much more expensive later to do it, if, as observers from the IMF on down, we get a chance to do it at all.

Stimulus, remember, must be timely, targeted, and effective. We should have had larger stimulus last spring, but we got a war spending bill and a rebate on the inflation tax. It was somewhat timely, but neither targeted, nor effective. Now we are running out of map, and the stimulus being proposed is still not well enough targeted, and is likely not to be effective enough to buy the time that we need.

Related posts:

  1. Fox News Slags Stimulus Bill for Being Too Republican
  2. Biden to Smack Boehner Around on Stimulus
  3. Eric Cantor Says Stimulus Bill Failed, Except That Whole Creating Jobs in His Home State Part
  4. NYT Can’t Recall that Republicans Who Demand “Where Are the Jobs?” All Voted Against the Stimulus
  5. Boehner Enlists Bloodhound to Look for Stimulus Jobs, Forgets They’re in His Home State