Catastrophe (5 page)
Authors: Dick Morris
Not until World War II broke out in 1939 did the American economy recover from the Great Depression and begin its rapid march back to full employment—a trend catalyzed by increased defense contracts and expansion of the military. The unemployed of the 1930s became the soldiers of the 1940s.
And when the war finally came to America in December 1941, the federal government’s purchases and contracts pushed the economy to full employment in a hurry.
So why wouldn’t Obama’s stimulus package have the same effect as the World War II spending?
Two reasons: First, because government spending during World War II was incomparably higher than anything we could contemplate today. Even though Obama is running a budget deficit that may rise to 13 percent of GDP, that doesn’t compare with the 30 percent deficit we ran in 1942.
Second, because in the 1940s contractors and businessmen knew that the war would go on for a while and that the new government orders wouldn’t dry up. So they didn’t hesitate to spend money to expand their produc
tion capacity and hire new workers. Today, everyone knows that Obama’s stimulus package is a one-shot affair. Even if he passes a second package, everyone knows it won’t last as long as America’s four-year involvement in World War II.
But why didn’t Keynes’s theories work in the 1930s? If taxpayers got refunds and workers got paychecks, why didn’t they spend the money? Why didn’t they flock to the stores to buy new products and services? And why didn’t that surge in demand lead to big increases in employment as businessmen raced to take advantage of the swelling market?
Because people have brains. They’re not animals who respond automatically to stimulation; they know what’s going on. In the 1930s, they realized that the new jobs the government gave out could end at any moment. They knew the tax refund checks they got were one-shot gifts that wouldn’t come around again. Their anxiety over the future paralyzed their ability to respond to the economic stimulus of the moment the way the economists had hoped.
Likewise, business executives of the time knew that any sudden bump-up in sales was due not to an end of the recession but to the artificial, one-shot stimulus provided by the government. Once it was spent, it’d be back to the same old depression. And so, rather than taking the revenue generated by momentary sales upticks and investing it in new factories or hiring additional workers, they put the money into safe Treasury bills and waited for better times.
What about tax cuts? Were they a better way of implementing Keynes’s theories? Did refund checks in the mail create the demand Keynes craved?
The experience with one-shot tax reduction or stimulus checks has been even more dismal that that with spending increases.
Earlier in 2008, faced with a faltering economy, George W. Bush and the Republican Congress approved a stimulus check program for American taxpayers. More than $100 billion went out, an average of $950 per family.
34
What happened? Nothing. The economy remained flat. Later, academics concluded that only 10 to 20 percent of the money had actually been spent on new goods and services.
35
The rest was just used to pay down bills or reduce debt—neither of which created any jobs.
In the past two decades, Japan has faced a very similar challenge. Saddled with a protracted recession with no growth and stubborn unemployment,
the Japanese government has been borrowing like crazy, spending money on public works projects year after year—with no real effect.
It was a sobering comedown for the once-thriving nation. In the 1980s, the Japanese economy soared. In the four years 1987 through 1991, the country’s GDP rose by 31 percent. Yet in the fourteen years that followed—from 1991 until 2005—it rose by only 10 percent!
The Japanese economy made slight gains in 2006 and 2007, but when
the global economy caved in, the Japanese crash was worse. In the last quarter of 2008, according to CNN, the Japanese economy shrank at an annual rate of 12.7 percent.
36
GROSS DOMESTIC PRODUCT IN JAPAN
Source: IMF Financial Statistics Yearbook.
It wasn’t that the Japanese government wasn’t trying to stimulate the economy all those years. It was following the same, futile Keynesian path that Obama is pursing—with no effect.
Here is the dismal history of Japanese efforts to spend their way into prosperity:
WHEN JAPAN TRIED OBAMA’S PROGRAM
37
1992
As the stock market sinks 60 percent, Japan launches a Keynesian economic stimulus program, passing an $85 billion stimulus package (approximately double it to get the U.S. equivalent). Net result: investment keeps falling and unemployment rises. By the end of the year, Japan’s debt-to-GDP ratio is 68.6 percent.
1993
Japan spends $117 billion on public works and small businesses and announces widespread tax cuts, along with a program of deregulation and decentralization. Result: the economy gets worse; GNP shrinks by 0.5 percent.
Later in 1993, the government spends $59 billion on low-interest home financing, “social infrastructure,” and business. The economy doesn’t respond. By the end of the year, Japan’s debt-to-GDP ratio reaches 74.7 percent.
Is any of this beginning to sound familiar?
1994
The government passes a new $150 billion stimulus package, including a one-year income tax, public investment, aid to small businesses, and employment support. The economy remains stagnant; the country’s prime minister, Morihiro Hosokawa, resigns amid a corruption scandal. By the end of the year, the country’s debt-to-GDP ratio rises to 80.2 percent.
1995
The new government spends $137 billion on another stimulus program. No improvement.
1996
Facing a huge and growing deficit, the Japanese government raises the consumption (sales) tax from 3 percent to 5 percent. The economy goes from bad to worse.
1998
Japan passes another stimulus package, this time worth $128 billion. It doesn’t work. Later that year, it passes yet another stimulus, the largest ever: $195 billion. By the end of the year, the country’s debt-to-GDP ratio reaches an astonishing 114.3 percent.
1999
The government passes a new stimulus package of $70 billion. The debt-to-GDP ratio reaches 128.3 percent.
Source: Wall Street Journal.
All told, Japan spent about $1 trillion (double it to find the U.S. equivalent) in trying to jump-start its economy. By April 2009, the debt-to-GDP ratio was an incredible 217 percent. What did it get for its trouble? An average growth of .6 percent a year!
All that trouble for nothing.
So how can anyone still believe that the Keynsian approach—which didn’t work in the United States in the 1930s, in Japan in the 1990s, or again in the United States in 2008—stands any chance of working in 2009?
Yet Keynesian economics remains the conventional wisdom—not of economists anymore, but of the mainstream media. As the economist Mark Skousen writes in his book
The Big Three in Economics,
“If a country falls into a military conflict, a deep slump, or other crisis, the Keynesian model immediately comes to the forefront: maintain spending at all costs, even if it means significant deficit financing. The misleading Keynesian notion that consumer spending, rather than saving, capital formation, and technology drives the economy, is still very much in vogue in the halls of government and in financial circles.”
38
The
Wall Street Journal
points to a key flaw behind the model: “Keynesian ‘pump-priming’ in a recession has often been tried, and as an economic
stimulus it is overrated. The money that the government spends has to come from somewhere, which means from the private economy in higher taxes or borrowing. The public works are usually less productive than the foregone private investment.”
39
But don’t take our word for it. A wide range of economic experts is already on the record as disagreeing with Obama and predicting failure for his stimulus package.
TOP ECONOMISTS SAY NO TO OBAMA’S STIMULUS PROGRAM
GARY BECKER, WINNER OF THE NOBEL PRIZE IN ECONOMICS:
“I tend to believe that [estimates of stimulus from government spending] are excessive. They will be put together hastily, and are likely to contain a lot of political pork and other inefficiencies. For another thing…it is impossible to target effective spending programs that primarily utilize unemployed workers, or underemployed capital. Spending on infrastructure, and especially on health, energy, and education, will mainly attract employed persons from other activities to the activities stimulated by the government spending. The net job creation from these and related spending is likely to be rather small. In addition, if the private activities crowded out are more valuable than the activities hastily stimulated by this plan, the value of the increase in employment and GDP could be very small, even negative.”
40
ERNIE GROSS, PROFESSOR OF ECONOMICS, CREIGHTON UNIVERSITY:
“We’re creating a real problem for 2010 and beyond in terms of inflation, tax rates, and certainly in terms of debt.”
41
GEORGE REISMAN, AUTHOR OF
CAPITALISM: A TREATISE ON ECONOMICS:
“That [increasing government spending to stimulate growth] is a view held by a large school of economists, perhaps the majority school, for the last 60 years or so. That’s the Keynesian school, but there are other economists, like
the Austrian school, which holds a very different position…. In their view, an essential requirement to a sound economy is balanced budgets with small government.”
42
ROBERT BARRO, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY:
“This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people.”
43
ARNOLD KLING, MERCATUS CENTER FINANCIAL MARKETS WORKING GROUP:
“[T]he risks of a large stimulus, compared with a small stimulus, are:
- It is harder to spend larger amounts quickly and cost-effectively.
- There is a greater risk that we will run into a “sudden stop,” in which foreign investors are no longer willing to fund our deficits.
- There is a risk that fiscal stimulus, large or small, is actually ineffective, so that a large stimulus only means a large failure.
- There is a risk that much of the spending will kick in after a recovery is underway.
- The government’s capacity to deal with an emergency, such as a major natural disaster or a foreign attack, will be limited, because its credit worthiness will be damaged.
- There is a risk that government will absorb a permanently higher share of GDP. Policymakers will be reluctant to cut public spending for fear of causing a downturn. Moreover, it will be difficult politically to cut public spending.”
44
THOMAS SARGENT, PROFESSOR OF ECONOMICS, NEW YORK UNIVERSITY:
“The calculations that I have seen supporting the stimulus package are back-of-the-envelope ones that ignore what we have learned in the last sixty years of macroeconomic research.”
45
GREG MANKIW, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY:
“My advice to Team Obama: Do not be intellectually bound by the textbook Keynesian model. Be prepared to recognize that the world is vastly more complicated than the one we describe in Econ 101. In particular, empirical studies that do not impose the restrictions of Keynesian theory suggest that you might get more bang for the buck with tax cuts than spending hikes.”
46
EUGENE FAMA, PROFESSOR OF FINANCE, UNIVERSITY OF CHICAGO BOOTH SCHOOL OF BUSINESS:
“Unfortunately, bailouts and stimulus plans are not a cure. The problem is simple: bailouts and stimulus plans are funded by issuing more government debt. (The money must come from somewhere!) The added debt absorbs savings that would otherwise go to private investment. In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another.”
47
JOHN TAYLOR, PROFESSOR OF ECONOMICS, STANFORD UNIVERSITYV
“The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market.”
48
As this book goes to press in April 2009, the nation’s jobless rate continues its upward climb. The economy swallowed the 2009 part of the stimulus package, burped, and went nowhere.
