One of the great (and incredibly wrong) theories from stimulus supporters is something we've seen in the arguments in favor of the 3-C passenger rail push by its advocates - that spending our money on a project that will barely be used will still create jobs - not only for those that build and run the railroad, but for the businesses they claim are bound to sprout up upon completion of the rail system.
Well, that sounds good in theory. In practice it's a bit more of a longshot.
But let's start from the beginning...
Imagine that I break my arm, but instead of getting a cast I take a big shot of morphine. The drug will make me feel better, but it won’t fix my arm. When the effect wears off, the pain will come back. And instead of being restored to their proper position, my bones will remain out of place, perhaps solidifying there, which will surely mean chronic pain in the long run.Indeed, they did.
Stimulus spending is like morphine. It might feel good in the short term for the beneficiaries of the money, but it doesn’t help repair the economy. And it causes more damage if it gets in the way of a proper recovery.
When the American Recovery and Reinvestment Act was signed on February 13, 2009, it became the biggest spending bill in the history of the country. Its original cost of $787 billion was divided into three main pieces: $288 billion in tax benefits such as a refundable tax credit; $272 billion in contracts, grants, and loans (the shovel-ready projects); and $302 billion in entitlements such as food stamps and unemployment insurance.The checks felt good for the Americans who received them. And the contractors who got those grants and contracts were happy to have the work. But the idea behind the stimulus was that this money would not just be a subsidy to those in need; it would revive the economy through a multiplier effect. The unemployed worker, for instance, would cash his unemployment check and spend it at the grocery store. The store owner would in turn spend the money on supplies, and so on, triggering a growth in the economy that goes beyond the original investment and jumpstarts the hiring process.
White House economists used forecasting models that assumed each dollar of spending would trigger between $1.50 and $2.50 of growth. As a result, President Barack Obama announced that his plan would grow the economy by more than 3 percent and “create or save” 3.5 million jobs over the next two years, mostly in the private sector. These models also forecasted that without the spending, the unemployment rate would increase from 7 percent to 8.8 percent.
Since then the U.S. economy has shed another 2.5 million jobs and the unemployment rate has climbed to 9.6 percent. Figure 1 shows the monthly unemployment rate, as measured by the Bureau of Labor Statistics, since the adoption of the act, alongside the cumulative grant, contract, and loan spending as reported by the recipients on recovery.gov.
The stimulus isn’t working because it is based on faulty economics. Using historical spending data, the Harvard economist Robert Barro and recent Harvard graduate Charles Redlick have shown that in the best case scenario, a dollar of government spending produces much less than a dollar in economic growth—between 40 and 70 cents. They also found that if the government spends $1 and raises taxes to pay for it, the economy will shrink by $1.10. In other words, greater spending financed by tax increases hurts the economy. Even if the tax is applied in the future, taxpayers today adjust their consumption and business owners refrain from hiring based on the expectation of future tax increases, which worsen the economy today.
Unless you believe that federal spending magically conjures up purchasing power (or that morphine heals bones), the total GDP will remain unchanged, because the federal government has to borrow the stimulus money from either domestic or foreign sources. This borrowing in turn reduces other areas of demand.
Stimulus spending does not increase total demand. It merely reshuffles it, leaving the economy just as weak as before—if not weaker, since it also increases the national debt. By trying to ease the pain, the administration may well have made the patient worse.
But what's past is past.
Now the voters have spoken. They didn't like how their country was being run. That includes the stimulus. Obamacare. Cap & Trade. And on and on...
Fortunately, there's a new sheriff in town. And things are gonna be run quite a bit differently.
Go get 'em, Mr. Boehner.