Why Government Intervention? The Promise and the Pitfalls

March 30, 2009

The American economy is in the middle of a ferocious retrenchment.  The statistics are not in dispute. The economy shed more than 651,000 jobs in February 2009, on top of more than 500,000 lost in January, bringing the total number of Americans looking for work unsuccessfully to a staggering 12.5 million. The national unemployment rate is a record 8.1%, a thirty year high.  Drilling down below the national averages the numbers are much worse for some groups. The unemployment rate last month was 13.4% for African Americans and a whopping 21.6% for teenage workers. A distressing 15 % of the unemployed have a college degree.  This is a huge waste of precious national resources, and a personal tragedy for those unemployed, and their families.

According to the most recent estimates from the Bureau of Economic Analysis, in the 4th quarter of 2008, the total economic pie or the Gross Domestic Product contracted a stunning 6.2% on annualized basis. The declines were deep and cut across all sectors of the economy.  The only sector where demand increased was government spending and net exports since imports were down. Warren Buffet, the world’s most famous investor and a shrewd student of the economy, appropriately described the situation as “an economic Pearl Harbor.”

It is not surprising that the average citizen is confused and scared.  There are many unanswered questions.  What happened? How did we get here? How could some of the world’s most profitable businesses make such bad decisions? Why were so many analysts wrong? How could politicians, government officials, and regulators create this mess?  Did institutions of democracy and capitalism fail the people of America?

There is plenty of blame to go around.  Clearly as some of those responsible have paid a price for poor judgment, many have not and will repeat these errors. According to most unbiased analysts, the current economic malaise originated in the growth and eventual collapse of a massive housing bubble; subsequent meltdown of several large firms in the bloated financial sector, that led to a freezing of the credit markets for important segments of the private economy.

The cumulative impact of greed, excesses, and hubris in Wall Street and Government’s halls of power was a catastrophic meltdown in the financial heart of the nation, and a collapse in the real economy that has cascaded to the rest of the world. In a blink of the eye, a staggering $8 trillion dollars in wealth has disappeared, mostly in equity markets and business bankruptcies.  Despite a massive $700 billion bailout of the rogue financial companies, and an equally big stimulus package, the economy is yet to stabilize from its downward spiral.

Thanks to globalization, the crisis in the US economy has rapidly spread throughout the global economy, infecting one nation after another. Historians have to go all the way back to the stock market collapse of 1929 and the ensuing Great Depression of 1930s to find a crisis of similar depth and proportions; the Great Depression was also caused by the collapse of an overly bloated economy and stock market from excessive destabilizing speculation that eventually spread to shutter down thousands of banks sending the economy into a tailspin.

The trillion dollar question is, should the Federal government wait for the economy to self-correct, or urgently intervene to prop up the economy? Consider some numbers.  If the economic decline continues at this pace, unemployment rate could be at double digits by summer of 2009.  For a $14.3 trillion economy, a one percent negative growth in the GDP results in the potential income loss of roughly $143 billion on an annualized basis. If the fiscal stimulus can be a catalyst for even a few points of GDP growth, it will pay for itself in greater incomes and output.

If nothing is done, no one knows how long it will take the economy to recover on its own.  Analysts point to almost ten lost years in Japan once it real estate bubble burst in the early 1990s.  Fortunately, we can learn from Japan’s experience and not repeat errors made by their policymakers.  It is unnecessary that American workers and businesses suffer through years of a painful recession which would erode the nation’s competitive position in the global economy.  Most economists agree on what ails the economy, and time tested remedies are available.  A sufficiently large stimulus in the form of a combination of direct government expenditure and tax cuts should jolt the economy back to path to full recovery.  Like a bitter medicine given to a sick patient, the stimulus may take time to work, and there would be some unpleasant side effects, but it eventually it would work.  It is a small down payment for more robust growth in the long run.

Munir Quddus is a Professor of Economics and Dean of the Business School at Prairie View A&M University, Texas. He writes on the history of economic ideas. He can be reached at

e-mail: muquddus@pvamu.edu.

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