Deficit "stimulus" is not the road to economic recovery. It's the problem, not the solution, writes Nobel laureate economist Vernon L. Smith, who grew up in Depression-era Kansas. Plus, read the original manifesto to reboot America produced by top economists and read the complete list of manifesto backers.
Last October a Rasmussen poll was already showing that only one-third of likely voters believed that the stimulus package was helping the economy. You, your fellow citizens and Congress are now concerned that the main effect of the federal stimulus has been to increase the burden of a swollen government living beyond its means. You were told that the stimulus was justified because it would jump-start the economy, setting in motion a recovery that would increase output by more than its increased deficit cost. But you are skeptical that there has been any recovery, and think that you have been misled by the president and the economic experts.
Your doubts have received bipartisan reinforcement. The $860 billion stimulus under the Obama administration was preceded by a $170 billion Bush stimulus that was said to be ineffectual because it was too small. Out of fear, people tended to use the Bush stimulus checks to pay down debt and to increase saving. Unemployment was rising, and large numbers of home owners were already living in homes worth less than what they owed the bank. It is now worse. In the five most severely affected states, here is the percentage of homeowners who owe more than their home is worth: Nevada (70%); Arizona (51%); Florida (48%); Michigan (38%); California (35%). Our current crisis was brought on by government and private programs designed to make it easier for people to buy homes. The result was an unsustainable housing bubble, and ensuing crash that put banks, businesses and households all in debt-reduction mode.
“Our best shot at increasing employment and output is to reduce business taxes and the cost of creating new start-up companies.”
The case for government deficit spending was that idle unemployed labor and capital would be put to work to increase the output of goods and services. Hence, a dollar of government spending would produce more than a dollar of new output because of the “multiplier effect.” Robert Barro of Harvard has studied wartime and defense spending, and found a multiplier of only 0.8. But those were better times, when businesses, banks, and consumers were not primarily concerned to use new income to pay down debt or save to protect against income loss. Even in better times there wasn’t much bang for the buck.
So what has been the government’s response in the current crisis? Besides spending stimulus, it was tax incentives for new home buyers and cash for clunkers if you bought a new car. All three are programs for borrowing output, homes and cars from future production and sales. Using subsidies to pump up home sales beyond what people could afford was the problem that led to the crisis. Now the problem is touted as the solution.
We are in times not seen since the Depression, when at its depth in 1934 my parents lost their Kansas farm to the bank. Such memories and the intensity of the current crisis led me and my colleague, Steven Gjerstad, to examine the last 14 recessions including the Depression. We have been surprised and dismayed to learn that in 11 of these 14 recessions the percentage decline in new house expenditure preceded and exceeded percentage declines in every other major component of GDP. Hence the sources of the current debacle are hardly new! Moreover, past recoveries in the housing market have been closely associated with recovery from recession. The latest data continue to tell us that the turnaround in housing, consumer durables, and business investment are all anemic.
Our past housing and government spending mistakes leave us with no good choices. But please no more government spending! The deficit must now be faced. Avoid any new taxes; they are unlikely to reduce the deficit without discouraging recovery.
Our best shot at increasing employment and output is to reduce business taxes and the cost of creating new start-up companies. Don’t subsidize them; just reduce their taxes even as they become larger; also reduce any unnecessary impediments to their formation. This is strongly indicated by the business dynamics program of the Bureau of Census and the Kauffman Foundation which has tracked new startup firms in the period 1980-2005. The entry of new firms net of departing firms in this period account for a remarkable two-thirds more employment growth (3 percent per year) than the average of all firms in the US (1.8 percent per year). The invigorating turmoil created by new technologies, with accompanying growth in output, productivity, and employment lead to new business formation as old firms inevitably fail. Reducing barriers to that growth encourage a recovery path which does not mortgage future output.
Vernon L. Smith, the George L. Argyros Professor in Finance and Economics at Chapman University, is a 2002 Nobel Laureate in Economics.