Over Stimulated

Can government spending end a recession? Those crazy bastards at the Heritage Foundation think not. In a well written piece in last week’s Wall Street Journal, Brian Riedl (the Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation (1)) argues that the great Keynesian federal money enema of 2009/10 will not only add bupkis to the short term national income, it will kill us in the long term.

Riedl sums up his argument by explaining where stimulus money comes from:

“Congress cannot create new purchasing power out of thin air. If it funds new spending with taxes, it is simply redistributing existing purchasing power (while decreasing incentives to produce income and output). If Congress instead borrows the money from domestic investors, those investors will have that much less to invest or to spend in the private economy. If they borrow the money from foreigners, the balance of payments will adjust by equally raising net imports, leaving total demand and output unchanged. Every dollar Congress spends must first come from somewhere else.”

Those in favor of stimulus and yet more stimulus may concede the “where it comes from” argument but would counter by noting the benefits of pumping magic money into the economy. Stimulus seekers could say that there is a multiplier effect from government spending. In fact, the Obama administration contends that virtually all stimulus spending creates or saves jobs and therefore has a multiplier effect of around 1.5. Simply put, for every $1 sent out through stimulus spending a $1.50 is eventually created in the wider economy.

Now comes the fun; It is impossible to measure a multiplier and anyone who says they can is either a college professor or someone trying to sell you something. But let’s not allow spurious data and intellectually bankrupt methodologies to slow us down. Let’s accept the idea that multipliers are measurable and see where it takes us.

Let us assume a revenue neutral program in the same vein as food stamps or unemployment insurance in that we are not expecting an annual return from the expenditure. What we are expecting is the passing along of that $100 to other participants in the economy thus promoting growth. Now let’s say the government borrows $100 from you or increases your taxes by the same amount and uses it to plant grass in an old parking lot to make it look better, become green, and provide a frequently unemployed local (we’ll call him Cletus) with a modest steady job mowing the grass. At first blush this seems like, and can even be measured as, a win/win. Let’s also assume all materials are purchased locally and all pre-Cletus labor is local as well.

So what’s bad about our imagined cash for grass program? As the saying goes, it’s what happens next that counts. Your $100 is a one time multiplier. It added value once and cannot create additional value to support the new lawn or Cletus. Eventually, additional funds will have to be allocated to maintain the Fescue-Cletus industrial complex. The value of the money you gave to or was taken from you by the government drastically decreases over time. Had that money stayed in a bank (and been loaned out) or invested in a business it would have had a much better chance of generating lasting value and thereby providing a long term multiple. The economy may have to wait longer and experience a smaller rush than with the cash for grass program but over time there would be greater benefit. How much is arguable depending on the nature of the investment or savings.

Could there be a different result had your $100 gone to a green energy startup? My guess is yes but there are private sector players in place who can invest your $100 in startups and can do it with less overhead and are held accountable in ways government can’t be (when was the last time a congressman from Massachusetts was fired?).

So what’s my point? If the government insists on redistributing or borrowing money to put a spark in the economy, let’s make sure it’s limited to those things the it can do that the private sector can’t (not much), like properly funding unemployment insurance and food stamps. And as for Cletus and his family, we should ensure his participation in the economy through providing opportunity and support rather than a push onto a government plantation.

Later.


(1) I’m wondering if the Heritage Foundation is going the way of the college bowls in its approach to sponsorship. Could we eventually see the Tostitos and Miller Lite Fellow in Consumer Affairs in the National Car Rental/Chick-fil-A Institute of Over Consumption?