Rebooting the economy: The House stimulus package is bitter medicine for a sick economy

Munir Quddus
Online Journal Guest Writer
http://onlinejournal.com/artman/publish/article_4314.shtml

Feb 3, 2009, 01:40

The $819 billion stimulus package approved last week on a 244-188 vote is historic given its size and scope.

It is surprising that the House Republicans did not find anything in the bill to support given that the bill includes at least $275 billion dollars in tax cuts. The Republican support for the Senate’s version of the stimulus package will send a strong symbolic message in these troubling times.

Although, the House bill in its current form is not perfect, it is the right medicine for an ailing economy that shows signs of getting much sicker rapidly. The medicine is never pleasant and sometimes bitter, but if the patient is on the operating table, there are few alternatives to the bitter medicine.

Most economists, including several who have won the Nobel Prize in economics, agree that waiting for the economy to right itself, or to employ the single weapon in the government arsenal acceptable to the House Republicans, a tax cut, will not do the trick. This much is evident from the experience in recent years. In a $14,000 trillion economy, a loss of one percent in the GDP growth represents a loss of nearly $140 billion in incomes and a large reduction to the tax base. If the stimulus package succeeds in adding even 3 to 4 percentage points to the GDP growth in 2009 and 2010, it would have more than paid for itself.

The statistics on the economic slowdown are not in dispute. The US economy officially fell into a recession in December 2008, with the unemployment rate at 6.5 percent, the highest in 14 years. A record 1.2 million Americans lost their jobs in 2008. This represents a loss of roughly $100 billion in incomes each year. If nothing is done, some economists have predicted millions more will join the ranks of the unemployed, as the unemployment rate could reach 8.5 percent by the end of 2009.

Consumer confidence is down sharply and most worrisome is that the financial sector remains in total disarray with a real possibility that large parts of the banking sector may have to be temporarily nationalized. Even though aggressive moves by the Federal Reserve seem to have averted a financial and economic cataclysm, the deepening economic crisis is unprecedented and calls for fresh and bold solutions.

According to Mark Zandi, chief economist of Moody’s Economy.com, “The economy’s long-term, underlying growth prospects have been reduced, not forever but maybe for five or 10 years.”

Warren Buffet, the billionaire investor, recently described the US economic situation to “an economic Pearl Harbor.”

U.S. Rep. Kevin Brady (R-8th Dist, Texas) explained his opposition to the bill in an article published in the Houston Chronicle last Friday. He argued that historically the stimulus packages have seldom worked, and their impact are usually too little and too late. He believes that there is a chance that the stimulus package may do more harm than good “as middle class families and small businesses ultimately shoulder the higher taxes needed to pay for this spending spree.” He went on to say, “I can’t find an economist anywhere who will admit that contraceptives, zoo exhibits and repairs to the Jefferson Memorial are serious economic boosts.”

I am not sure which economists Rep. Brady is listening to, but along with many of my fellow economists, I believe that government spending can stimulate a slowing economy by creating new jobs and incomes. Most macroeconomic models show that in times of such acute distress, direct government spending, not monetary policy, has a better chance of quickly stimulating the economy to create new jobs and incomes in an ever expanding virtuous cycle as the multiplier effect works through the economy. How do we know this?

Let us begin with the ideas of a famous 20th century economist, Lord Keynes. A Cambridge University professor who had worked at the highest levels in government published his last major book, The General Theory of Income, Employment and Income in 1936. The ideas expressed in this book eventually came to be known as the Keynesian Revolution in economics. Keynes produced a fresh and logical analysis of the economic malaise — that it was caused by insufficient demand that can only be corrected by government spending to boost aggregate demand. His recommendations were embraced by most professional economists around the world. Keynes met President Roosevelt who adopted many of his suggestions. The New Deal programs and the vastly enhanced government borrowing to finance the war spending finally pulled the US economy decisively out of the Great Depression. Remember war spending is also a form of government direct spending.

Keynes’ model completely upended the orthodoxy called Classical economics which was based on Say’s Law — the idea that supply creates its own demand in the economy. In other words under the Classical model of economics, production will always result in sufficient income and demand, so that there is never a situation of over production or recession. Since there will never be a recession in the economy, there was scarce need for government intervention. The central bank’s control of liquidity (monetary policy) should be sufficient to ensure full employment and economic growth. This rosy view of the full-employment economy ran into a brick wall in the years after the stock market crash of 1929 and the resulting banking crises. The economies in most of the industrialized world were stuck in a long and deep recession — The Great Depression of the 1930s — and this demanded new models and solutions. The Classical economists had no good answers to get the economy out of the deep and painful economic contraction. The same seems to be true of the position taken by the House Republicans today.

A lot has happened since 1936 and the New Deal. Economic science has progressed. Keynesian ideas considered revolutionary in 1936 are now conventional wisdom. These ideas even sparked a counterrevolution by University of Chicago’s Milton Friedman who revived the Classical model. However, with the collapse in the financial markets and its disastrous impact on the real economy, the pendulum of fashionable ideas is swinging back to the Keynesian model. The mantra of “tax cut for a trickle down solution” and “market knows what is best” stands discredited by the global financial crises.

President Barack Obama and his economic team are the main force behind the House stimulus package. The bill presents a strategy to combine tax cuts and spending increases to jumpstart a badly ailing economy. Many in the business world support the effort. It is unfortunate that millions of Americans who are suffering because of lost jobs and closed businesses are not very vocal. Since they don’t contribute to campaigns as much or employ lobbyists, few politicians speak for them.

The stimulus package includes an estimated $544 billion in new spending and $275 billion in tax reductions mostly for middle income households and businesses, including small businesses. Given the nature of the political process, there are some “shock and awe” type of spending programs in the bill. However, the emphasis is on job creation, immediate relief, investments in education and healthcare, and infrastructure. The bill includes scores of programs to rebuild the fading infrastructure, such as highway construction and mass transit projects, but far more is reserved for immediate relief to those impacted most severely by the slowdown through unemployment benefits, health care and food stamp programs.

The intent of the stimulus package is not to increase welfare, but to create new jobs and save businesses from going under. Tens of billions will go to states to shore up their tottering budgets, and additional funds are set aside to build schools, improve law enforcement and improve energy efficiency.

The president said, “This recovery plan will save or create more than 3 million new jobs over the next few years.”

On the tax relief side, there is a $500 tax break for single workers and $1,000 for couples, including those who don’t earn enough to owe federal income taxes. This last piece is especially irksome to House Republicans as they consider this to be welfare.

To conclude, under normal circumstances few economists like deficit financing, but these are troubling times. During a deep and worsening recession, most economists support government spending as the most effective antidote to the slowdown. Economists understand a percentage of the spending will be wasteful, but the need to reboot the economy for the greater good of the society trumps these concerns. Once recovery is on hand, spending should be quickly scaled back and new sources of revenues added to reduce the budget deficit, and cut the menacing national debt.

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