At the Wall Street Journal,
The Keynesian Dead End
Spending our way to prosperity is going out of style.
Like many bad ideas, the current Keynesian revival began under George W. Bush. Larry Summers, then a private economist, told Congress that a “timely, targeted and temporary” spending program of $150 billion was urgently needed to boost consumer “demand.” Democrats who had retaken Congress adopted the idea—they love an excuse to spend—and the politically tapped-out Mr. Bush went along with $168 billion in spending and one-time tax rebates.
The cash did produce a statistical blip in GDP growth in mid-2008, but it didn’t stop the financial panic and second phase of recession. So enter Stimulus II, with Mr. Summers again leading the intellectual charge, this time as President Obama’s adviser and this time suggesting upwards of $500 billion. When Congress was done two months later, in February 2009, the amount was $862 billion. A pair of White House economists famously promised that this spending would keep the unemployment rate below 8%.
Seventeen months later, and despite historically easy monetary policy for that entire period, the jobless rate is still 9.7%. Yesterday, the Bureau of Economic Analysis once again reduced the GDP estimate for first quarter growth, this time to 2.7%, while economic indicators in the second quarter have been mediocre. As the nearby table shows, this is a far cry from the snappy recovery that typically follows a steep recession, most recently in 1983-84 after the Reagan tax cuts.
The response at the White House and among Congressional leaders has been . . . Stimulus III. While talking about the need for “fiscal discipline” some time in the future, President Obama wants more spending today to again boost “demand.” Thirty months after Mr. Summers won his first victory, we are back at the same policy stand.
The difference this time is that the Keynesian political consensus is cracking up. In Europe, the bond vigilantes have pulled the credit cards of Greece, Portugal and Spain, with Britain and Italy in their sights. Policy makers are now making a 180-degree turn from their own stimulus blowouts to cut spending and raise taxes. The austerity budget offered this month by the new British government is typical of Europe’s new consensus.
President Obama’s tragic mistake was to blow out the U.S. federal balance sheet on spending that has produced little bang for the buck. The fantastical Keynesian notion (the “multiplier”) that $1 of spending produces $1.50 in growth was long ago demolished by Harvard’s Robert Barro, among others. That $1 in spending has to come from somewhere, which means in taxes or borrowing from productive parts of the private economy. Given that so much of the U.S. stimulus went for transfer payments such as Medicaid and unemployment insurance, the “multiplier” has almost certainly been negative.
With the economy in recession in 2008 and 2009, we argued that some stimulus was justified and an increase in the deficit was understandable and inevitable. However, we also argued that permanent tax cuts aimed at marginal individual and corporate tax rates would have done far more to revive animal spirits, and in our view would have led to a far more robust recovery.
What the world has now reached instead is a Keynesian dead end. We are told to let Congress continue to spend and borrow until the precise moment when Mr. Summers and Mark Zandi and the other architects of our current policy say it is time to raise taxes to reduce the huge deficits and debt that their spending has produced. Meanwhile, individuals and businesses are supposed to be unaffected by the prospect of future tax increases, higher interest rates, and more government control over nearly every area of the economy. Even the CEOs of the Business Roundtable now see the damage this is doing.
- The Journal left one name out of this passage who should be there: then-Ohio Congressman John Kasich. The Associated Press, in a too-rare example of historically accurate reporting in June of last year (original BizzyBlog post; saved AP article), noted that Ohio’s current GOP gubernatorial candidate “was the chairman of the U.S. House of Representatives’ Budget Committee in 1997 that balanced the nation’s budget for the first time in more than 30 years.” More than any other person, Kasich was responsible for the relative spending restraint in the 1998 and 1999 fiscal-year budgets that led to the actual and projected budget surpluses of the period. The restraint started its disappearing act after Kasich left Congress, and his claim that free-spenders on both sides of the political aisle quietly celebrated his departure is sadly true.
- Unfortunately, I don’t agree that Obama’s and Congress’s decision to “blow out the U.S. federal balance sheet” was a “tragic mistake.” Given false intellectual cover by the likes of Larry Summers and Christine Romer, the administration and Congress gleefully did so. Perhaps Obama, Pelosi, and Reid are still deluded, as are Summers and Romer, about the awful historical record of doctrinaire Keynesianism. If they’re not, the only alternative is to assert that they have inflicted their damage deliberately.
- Incredibly, no one except GOP candidate Rudy Giuliani was advocating further tax cuts. Democrats and their presidential candidates, most notably Obama, advocated vast tax increases; GOP candidates McCain and Romney were satisfied advocating making the current tax structure which had been in place since 2003 permanent. That wasn’t good enough, guys.
- The FUDGE economy (Fear, Uncertainty, Doubt, and Government Excess) continues. The Business Roundtable’s tardy arrival to the corps of the concerned is no accident. The too-numerous band of crony capitalists in this group thought they would disproportionately benefit from a Washington-driven spending spree, and are late in recognizing that this administration’s hostility to the private sector was far more than election campaign posturing.
Most who understand at least rudimentary economics knows that some “stimulus” from government spending, coupled with other government actions, such as tax cuts for individuals and businesses, may have a beneficial effect in times of recession. The stimulus funds get money in circulation and the tax cuts encourage businesses to expand and hire.
What we’ve seen is nothing but “stimulus” – no tax cuts, no incentive for businesses to come off the side lines. Additionally we’ve seen attacks on the business community, calls for much more draconian regulation and new mandates imposed by legislation such as health care reform.
The result has been a seemingly perpetually unsettled business atmosphere that has provided absolutely no incentive for companies to expand or hire.
What we should have all taken from this is that government “stimulus” funded by massive public debt isn’t the answer we were led to believe it was and, when it is all that is done, is more of a problem than any sort of a solution. All the “stimulus” has managed to accomplish is the promise of large tax increases to pay down the debt it created.
The other service it hopefully has rendered is to prove defective the once cherished Keynesian belief that government can spend us out of recess.
And now for the bad news: Keynesian economics are not dead yet. Not by a long shot. For as long as there are politicians, there will be government spending as if there is no tomorrow.