THE BEAR'S LAIR
The un-stimulating stimulus
By Martin Hutchinson
Until the House Republican revolt this week, there has been a worldwide
consensus that the way to get out of a deep recession is through fiscal
"stimulus" - gigantic gobs of public spending that explode the budget deficit
but provide jobs to those without them. It's a theory first publicized by John
Maynard Keynes, but it rests on a central fallacy: the "job-providing"
expenditures have to be financed somehow, and their financing may crowd out
other private-sector projects that would have created more jobs.
Let's start by exploding a fallacy in the opposite direction that is popular
with some on the political right. It's not true that government expenditure is
in all cases less productive than private expenditure. Much private expenditure
goes to McMansions and
casinos, things society would be better without. On the government side, there
are a very few functions - defense and the administration of justice - that are
more efficiently carried out by government.
There are also a few cases of expenditures where a private sector operation
does not capture the external benefits of a project. The Interstate Highway
System was one such; its "social rate of return", including all the benefits to
society from its construction, was many times its economic rate of return, even
had all the highways been toll roads.
The Interstate Highway System was authorized in 1956 and completed in its
original form in 1992; however, real expenditure on the system fell off sharply
after 1971 and 83% of the system's mileage was open by 1973. A 1996 study by
the American Highway Users Alliance estimated the benefits of the system over
its then 40 years of existence at US$2.1 trillion to $2.5 trillion in 1995
dollars, around seven times its real original cost. Its annual benefit in 1995
was estimated at $78 billion to $110 billion, around 1.1% to 1.6% of gross
domestic product (GDP).
Not only was the Interstate Highway System nearly completed by the early 1970s,
its congestion was then far lower than it later became. Thus the early 1970s
will have seen its peak annual economic benefit. That benefit was considerable,
even in the context of the entire US economy.
An uncongested interstate system allowed travelers to calculate their travel
time with a high degree of reliability by dividing the miles traveled by 60, a
far more aggressive equation than would have been possible earlier, or indeed
later on the congested east and west coasts. Whereas the bus journey from
Florida to New York in the 1934 movie It happened one night took a week,
by 1970 it was perfectly feasible to do the drive in a day.
The reliability of an uncongested highway system was as important to
productivity as its additional speed; it made planning for journeys involving
the crowded east and west coasts much easier than before or after. Thus if the
system's benefit was 1.1% to 1.6% of GDP in 1995, it was significantly higher
in the early 1970s, perhaps 3% of that period's lower GDP (roughly half that of
1995, in real terms.)
The Interstate Highway System can thus be estimated to have added around 0.2%
to annual economic growth and productivity growth in the 15-year 1957-72
period.
Economists have for many years debated why productivity growth in the period to
1973 was consistently higher than that since that date; the Interstate Highway
System was certainly one reason for the difference. Indeed, its 0.2% annual
addition to productivity growth between 1957 and 1973 was more than a quarter
of the productivity growth differential between 1957-73's 2.49% per annum and
1973-2007's 1.78% per annum.
Thus the Interstate Highway System was the most productive expenditure the
Eisenhower administration could have undertaken, probably adding even more to
economic growth than would have been gained by a reduction in the ludicrous 91%
top income tax rate of the period.
Clearly, therefore, if President Barack Obama could find an equivalent to the
Interstate Highway System program in his inbox, it would provide economic
stimulus as the money was spent, long-term economic benefit from its adoption
and tax revenues from increased GDP down the road that would at least partly
pay for it. Such expenditures have a high Keynesian "multiplier" to use one
economic formulation, or a large "supply side effect" to use another that is
not always in opposition to the first.
The bad news is that such projects are extremely rare. Even viewed in the most
favorable light, the House version of the stimulus program doesn't have many of
them, if it has any at all. Going through the bill item by item:
1. Of the $27 billion agriculture spending, only $4 billion has any
positive spillover, for extending rural broadband Internet access. Not much
spillover though, as the private sector is already pretty active here.
2. Of the $14 billion commerce spending, $2.8 billion is for broadband
Internet and $3 billion for scientific research. Maybe $6 billion of the total
has positive spin-offs.
3. $4.5 billion for defense maintenance. Gets spent quickly, but no
significant spin-offs.
4. Of the $49 billion for energy and water programs, $18.5 billion is
for energy efficiency, $8 billion is to provide loan guarantees for renewable
energy, and $4.5 billion to modernize the electricity grid. The last has a
spin-off, but the others, not so much. Maybe $10 billion, and that's being
generous. Anyway, only about 20% of this money will be spent in 2009-10.
5. $8.7 billion to promote energy efficiency in government. Presumably
if this was economically beneficial, it would pay for itself in lower fuel
costs.
6. $15 billion for water infrastructure. Again only 20% spent in
2009-10; maybe $3 billion has spin-off benefits.
7. $92.3 billion for labor, human services and education programs. A
Congressional Democrat wish list, none of which looks to have significant
spin-off benefits without root-and-branch reform of the public education
system, which isn't on the agenda. Measurable educational or economic benefits
from the more than $200 billion so far spent on the 2001 No Child Left Behind
Act have been insignificant.
8. $6 billion for military construction. Probably no economic spin-off.
9. $59.5 billion for transportation and housing. Of this, $30 billion is
highway construction (give it the benefit of the doubt, but only about 20% will
be spent in 2009-10); most of the remainder is for housing assistance which is
of no economic benefit in an economy with such over-investment in housing.
10. $79 billion for stabilization of state budgets. This will mostly go
to the states that overspent most egregiously during the housing bubble. No
significant spin-off benefits.
11. $249 billion in increases in unemployment insurance, Medicaid
payments and so forth. No significant spin-off or supply-side benefits.
12. $188 billion in tax reductions, of which $13 billion would be
accelerated business investment write-offs and therefore has a supply-side
effect.
13. $40 billion to extend the COBRA health-care provisions for laid-off
workers. Some modest supply-side effect here; call it $10 billion.
14. A net $18 billion in subsidies for health information technology
spending, which will increase the efficiency of the health-care system - give
it the benefit of the doubt.
Of the roughly $850 billion in expenditures and tax rebates outlined above,
only roughly $81 billion in expenditures and $13 billion in tax reductions
would have any economic spin-off effect or supply-side effect respectively.
That's 11% of the total, much of it being spent in 2011 or later.
All the remainder would have a Keynesian multiplier of 1.0 or less, in other
words run the risk of being on a net basis damaging to the economy by sucking
resources out of other more productive uses.
Add to the above the financing and inflationary problems produced by a federal
budget deficit that was already out of control before this "stimulus" and the
waste and corruption inevitable in government programs of this size (such as
the infamous "Davis-Bacon" provisions adding 20% to federal construction costs
by requiring unionized labor). Add also damaging requirements such as the "Buy
America" provisions in relation to steel and manufactured goods, which
significantly raise the danger of a trade war that would hugely damage the US
and world economy.
It becomes pretty clear that, far from repeating the successes of the
Interstate Highway System, the proposed economic stimulus is likely to have a
net depressant effect on the US economy. Misguided large-scale government
activities of this kind produced the disaster of the Great Depression in the
United States at a time when Britain among other countries was able to achieve
economic recovery by pursuing the opposite policy of state retrenchment.
We're not in the Great Depression yet, nor close to it, but the House version
of this economic stimulus would take us a substantial further step in that
direction. Tax increases would also be necessary, beyond the already-scheduled
repeal of the Bush tax cuts at the end of 2010 (which itself will have a
negative supply-side effect) before the economy will have had time to recover.
Passing such a poorly thought-out stimulus, followed by a tax increase, is the
same mistake Herbert Hoover made in 1930-32. If the legislation reaches him in
something like this form, the intelligent President Obama should have the sense
to veto it.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-09 David W Tice & Associates.)
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