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Government Can’t Stimulate an Economy

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Barack Obama won’t use the “stimulus” label to describe the nearly half-trillion-dollar jobs bill he sent to Congress in September, but that refusal can’t hide the fact that he has no idea how economies recover from recessions. “Stimulus” is a tainted label because his $800 billion bill in 2009 was a failure. Somehow a package about half that size is supposed to succeed. His economic team promised that passing the first bill would keep unemployment from exceeding 8 percent. The bill passed, and unemployment climbed to more than 9 percent and has stayed around 9 percent ever since.

With election day not so far off, one can readily see Obama’s desperation for a job program.

The administration insists things would have been worse without that 2009 stimulus bill, but no good theory supports that assertion. Here’s the key: “Stimulus” implies that something enters the economy from outside, like a defibrillator applying an electrical shock to the heart. But any money the government appears to inject into the economy was already in the economy and therefore was just moved around. If the government cuts taxes but keeps spending, no net addition of resources is made. If it borrows or raises other taxes to cover the spending, the money has to come from somewhere.

Take Obama’s approach to the payroll tax, which even Republicans tend to like. His fall jobs program called for a continuation of his earlier cut for employees and a new cut for employers. (The employer side is to some extent an illusion because, depending on the state of a particular labor market, the employee actually pays most or all of it.) The logic is that the cut on the employee side provides more spending money (supposedly creating or saving jobs) and the cut on the employer side lowers the costs of hiring new workers (supposedly creating new jobs). The logic is not as sound as it looks on the surface, but that’s not my point here.

Let’s focus on the budget. The payroll, or FICA, tax of course finances Social Security and Medicare. Social Security and Medicare are already taking in less money than they need to pay retirees. So they will have to cash in more of the Treasury IOUs left behind when previous surpluses are used to finance general expenditures. But the Treasury is also already running a deficit, more than a trillion dollars. So it will have to borrow more in the capital markets in order to pay back the Social Security and Medicare funds. That is, unless Obama makes up the lost revenue by changing the tax code or raising taxes on the upper 2 percent of income earners. But then money will be withdrawn from the economy in the form of higher taxes so it can be put back into the economy through the payroll-tax cut. Somehow that’s supposed to stimulate the economy.

As George Mason University economist Russ Roberts says, government’s stimulus of an economy is equivalent to taking water from the deep end of a pool and pouring it into the shallow end. Thus, all talk of stimulus is nonsense. Both Democrats and Republicans have bought into this Keynesian nonsense, even if they wish to implement it in somewhat different ways.

What is a job?

Did the first stimulus create or save 3.5 million jobs, as the administration claims? It depends on what you mean by “create,” “save,” and “jobs.”

It is certainly true that the federal government gave money to the states and localities, and some of that money was used to pay teachers, police officers, and firefighters. However, saying the money “saved” those jobs implies they really would have vanished without federal money. In some cases, state and local politicians may have been engaging in fear-mongering. It’s happened before. But even if they weren’t, the claim assumes that if federal money hadn’t materialized, those politicians wouldn’t have found other things to cut in order to keep paying the teachers, police, and firefighters — the bloated administrative bureaucracies, for instance. We’ll never know because they were relieved of the necessity — the mother of invention — of making the “tough choices” they always say they are elected to make.

What about other jobs? Two recent studies by Garett Jones and Daniel Rothschild of the Mercatus Center demonstrate that most of the jobs were filled by hiring people away from jobs they already held. “[Hiring] people from unemployment was more the exception than the rule in our interviews,” the authors write. Some will claim that that is fine because the vacated jobs were available to the unemployed. But that implies highly skilled people were sitting around waiting for those jobs, and that is not the case. Moreover, the companies that lost employees had to incur high search and training costs to refill the jobs.

Supporters of Obama’s latest stimulus claim that repairing bridges and schools will put the unemployed to work. But it won’t happen because the unemployed aren’t typically qualified for such work. The thinking behind stimulus plans presumes that labor is easily interchangeable. It’s not. As one employer put it, “[The] type of construction home builders are trained for has nothing to do with bridges.” The federal government has increased infrastructure spending for 25 years, and Japan tried to jump-start its economy for 10 years with such projects. No economic miracles occurred.

There’s a deeper point. In economics a job is employment that creates value by helping to transform resources from a less-useful to a more-useful condition. In a free market, prices, consumer behavior, and profit-and-loss sheets signal whether that criterion is met. A job is not merely exertion for which someone is paid. In the case of government and government-financed jobs, where resources are acquired by force (taxation) and there is no market pricing at every stage, we can’t be sure that people who “work” actually create rather than destroy value. They may sweat, but that doesn’t mean they have jobs.

Real recovery

So, then, how does an economy recover? It doesn’t recover through central-bank policies aimed at keeping interest rates low, discouraging saving, or fiscal policies aimed at boosting consumption, including the government’s own consumption of resources. It doesn’t recover through reinflation of burst bubbles. Recessions (low to negative growth, unemployment, idle resources) follow booms and bubbles, which are caused by central-banking polices that fill the economy with cheap credit and regulatory programs that channel the credit into particular areas, such as the constellation of easy home-purchase policies carried out by several government agencies for years. The booms set off by those policies are characterized by a misshapen capital structure; that is, resources and labor were arranged according to price signals distorted by the central bank and other government agencies. For example, labor and equipment went into the housing and housing-finance industries to a vaster extent than they would have gone absent those price-distorting policies.

When interest rates finally rise to reflect reality, the boom ends, revealing the unsustainable nature of the misshapen capital structure. Businesses close, workers are laid off, and capital is left idle. The effect ripples beyond the immediately affected industries. If government were to retrench at that point, entrepreneurs would set out on the task of re-arranging resources and labor in order to align them with entrepreneurial estimates of future consumer preferences.

This rearrangement is neither costless nor instantaneous. Equipment made for one purpose may be unsuitable for other purposes and may have only scrap value, or it may be in the wrong location. Likewise, people trained to build houses or to work with financial computer models may not be qualified for other jobs and will need retraining. The work of changing the structure of production from its politically distorted shape to one that will better serve consumers requires money. There’s only one place that money can come from if the economy is not to be further distorted: savings. But saving is consumption deferred. Thus all government efforts to stimulate spending and discourage saving accomplish the opposite of what is required for economic recovery.

Free people create economic growth when government backs off — slashes spending and taxes, ends regulations and privileges — and lets them correct the mistakes induced by earlier monetary and regulatory stimuli. Nothing less will work lastingly.

This article originally appeared in the December 2011 edition of Freedom Daily. Subscribe to the print or email version of Freedom Daily.

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    Sheldon Richman is vice president of The Future of Freedom Foundation and editor of FFF's monthly journal, Future of Freedom. For 15 years he was editor of The Freeman, published by the Foundation for Economic Education in Irvington, New York. He is the author of FFF's award-winning book Separating School & State: How to Liberate America's Families; Your Money or Your Life: Why We Must Abolish the Income Tax; and Tethered Citizens: Time to Repeal the Welfare State. Calling for the abolition, not the reform, of public schooling. Separating School & State has become a landmark book in both libertarian and educational circles. In his column in the Financial Times, Michael Prowse wrote: "I recommend a subversive tract, Separating School & State by Sheldon Richman of the Cato Institute, a Washington think tank... . I also think that Mr. Richman is right to fear that state education undermines personal responsibility..." Sheldon's articles on economic policy, education, civil liberties, American history, foreign policy, and the Middle East have appeared in the Washington Post, Wall Street Journal, American Scholar, Chicago Tribune, USA Today, Washington Times, The American Conservative, Insight, Cato Policy Report, Journal of Economic Development, The Freeman, The World & I, Reason, Washington Report on Middle East Affairs, Middle East Policy, Liberty magazine, and other publications. He is a contributor to the The Concise Encyclopedia of Economics. A former newspaper reporter and senior editor at the Cato Institute and the Institute for Humane Studies, Sheldon is a graduate of Temple University in Philadelphia. He blogs at Free Association. Send him e-mail.