Tuesday, September 28, 2010

On the Need for a Second Stimulus

The growing chorus of "The Stimulus Didn't Work" is false and silly.  Moreover, calls for "fiscal restraint" or the need for everyone to "tighten their belts" is false and dangerous.  Finally, the suggestion that continuing the tax cuts for the top 2% of the country because they "create" jobs is false and tired.

Here's why:  the wealthy among don't "create" jobs.  This is Economics 101: DEMAND creates jobs.  No demand?  No jobs.  Think about this: what would happen if the government dropped the tax rate to zero on, say, profits from sales of Pet Rocks.  Would we suddenly have a booming Pet Rock industry?  Of course not.  Why?  Because no one wants to buy a Pet Rock.  There is no demand for Pet Rocks.  Conversely, there appears to be high demand for all sorts of illegal drugs.  Government has taken extreme measures to restrict the supply of illegal drugs.  But the drug business is booming.  Why?  Because people want to buy illegal drugs.  The demand remains high and, thus, the jobs are there.

The only time a supply shock (e.g. lower taxes on profits) can dramatically affect job creation is during a "supply deficit."  This happens when the demand is present but, for some reason, there isn't enough supply.  An example might be high-speed rail.  It's possible that lots of people would like to ride high-speed rail.  It might allow job seekers in Los Angeles and San Francisco to commute to the other city.  It could take people to and from Las Vegas or Dollywood rapidly.  But high-speed rail is expensive and takes lots of land.  It may take years and years for a business to recoup the billions needed to establish a high-speed rail line.  Also, one company may not be able to get the land-use rights to complete a full track.  THIS is where government policy can stimulate supply to solve the problem.  Here, providing a tax incentive to build rail lines, or lowering taxes on commuter-rail profits might entice supplies to enter the demand-rich market when they normally wouldn't.  But only then.

We are not in a supply deficit.  Companies have lots of cash, they're just not spending it.  Instead, we are in a demand deficit.  People don't have a lot of money, and those that do are saving it.  If no one's buying (Pet Rocks or anything else) then no one's selling and, thus, no jobs.

But didn't the first stimulus "fail?"  Of course not.  Quite the contrary -- it did exactly what it was supposed to do, it was just too small.

If I recall, the expected demand deficit was something like $2.5 trillion.  In other words, consumers were spending $2.5T less than they had previously.  Obama started out a stimulus proposal under $1T, included lots of tax cuts rather than spending (cuts are less stimulative), and then negotiated the amount down to around $800 billion.  Thus the stimulus was about one-third of what it would take to completely fill the gap.

To say “we did one-third of what we had to, and then things didn’t turn out well, means we should do even less going forward” is, in my opinion, dubious at best.

Think of it this way:  Imagine firemen arrive at the scene of a burning house.  They bring with them three hoses and hook them up to three fire hydrants.  But they decide to only use one due to worries about a drought in a few years.  After battling the fire for some time, they realize that they’ve made a little progress but the house is still burning.  At that point, one fireman says “Hey Fire Chief, we tried your water-based solution and it didn’t work.  We need to turn off the hose immediately.”

What would you do?

1 comment:

  1. What would I do?? I'd get more hoses and put out that fire!!!

    ReplyDelete