The limits of stimulus

Stimulus has its upside, but it is still a blunt way to fix a complex problem.

There is little doubt about it: The United States will be getting a fiscal stimulus. The Senate received the bill, passed by the House, and began its review this week. There is reason for pause. Some feel it is too small. Others worry government spending will not be as effective as tax cuts. While there have surely been examples of partisan bickering, there is a broad consensus that action is needed. The controversy over the billâÄôs construction reflects the lack of a concrete historical example of how to tackle the recession. The general thrust of the stimulus seeks to stimulate economic growth or, in other words, measured gross domestic product (GDP). The irony is that it is Democrats who support it. Liberals traditionally and correctly fret that GDP and other macro-measures of the economyâÄôs wellbeing do not account for the inequities that exist in society. Thus, if the goal is to throw money at the economy until some part grows enough to pull measures into the black, then skepticism is warranted. There is a case to be made, however. A recession is basically a contraction of the money supply. Today, people are spooked by all the news of banking crises and dire economic indicators. People are now hoarding money, creating what is called the Paradox of Thrift âÄî basically, a dollar you save is a dollar lost in someone elseâÄôs income. A massive show of commitment by the government to âÄúdo somethingâÄù may persuade people to resume more normal spending habits. Such a hope is legitimate, if far from guaranteed. A crucial component of fighting the recession, the global economy, has been largely left out of the discussion. So far, there has been little official concern about the extent to which the rest of the world plays a role. The United States was the driver of the world economy leading up to the crisis, partly because American households were the spenders of last resort. A stimulus aimed at restoring consumer demand in the United States is basically an attempt to return to pre-crisis routines that were clearly unsustainable. The housing bubble was, in fact, a part of a greater credit bubble, generated by global imbalances. This term has, of late, been used in a pejorative sense, attempting to pin blame on China for accumulating massive amounts of foreign currency reserves as a result of its currency manipulation. The United States has been running dramatic trade deficits in recent years, peaking at about $800 billion . A deficit means imports exceed exports, with a surplus being the opposite. Many East Asian and Middle Eastern oil states have surpluses that needed to be invested to protect their value from being eroded by inflation. These developing countries, by and large, did not have the capacity to absorb investment themselves, lacking strong financial markets. The money thus flowed into the developed world. The United States, with the biggest financial market, began to absorb the money, but so did Europe. Many European countries face worse housing busts than the United States. Domestically, there was an imbalance, as well. The huge trade deficit had to be accounted for by a sector in the economy. Prior to the crisis, corporations were, on average, cash surplus. Thus, it was the household sector âÄî indeed, the consumer âÄî that began to borrow to utilize all the credit that was available from the financial sector. So what do these imbalances have to do with the stimulus? Many stimulus proponents use the public sector works during the Great Depression as evidence of their potential. The real policy action to bring back growth, though, was World War II. Through the 1920s and before the Depression, the United States was the China of the world âÄî a huge exporter and holder of large gold reserves (the gold standard was still in effect). In 1945, the United States emerged from wartime to a destroyed world that had a good appetite for exports and little productivity capacity of its own (which helps explain the strength of U.S. manufacturing for the next few decades). That type of global imbalance is not present today. To be fair, there is little time to prepare dialogue on what would be a huge undertaking. Rather than attempt this, some lawmakers have thought a trade war a better idea. The âÄúBuy AmericaâÄù provision requires the use of American steel in infrastructure projects. This act, considered protectionism, is seen as a modern day Smoot-Hawley Tariff Act âÄî the Depression-era legislation that is famous for inciting a trade war. To say that trade collapsed in the 1930s seems an understatement, and it was a contributor to the severity of the downturn. Europe has already threatened to block U.S. exports if âÄúBuy AmericaâÄù passes with the bill. Long shadows cast doubt on the wisdom of some of the stimulus provisions. Aid for state budgets makes sense. So do strengthened unemployment benefits. Green investment and infrastructure are necessary, but shifting to a green economy will dislocate jobs in dirty industries. Infrastructure, while in poor shape, needs to be weighed against the future solvency of the government. There is not much evidence that bridges pay for themselves. Quicker recovery would likely leave a variation on the pre-2007 economy, prone to the same failings. Politically, that may be considered a success. Ah, what a fine mess. St. JamesâÄô Street welcomes comments at [email protected]