Short Term Gain, Long Term Pain

In remarks yesterday before a gathering of Energy Department employees, President Barack Obama said with regard to the American Recovery and Reinvestment Plan (stimulus package) now under consideration by Congress:

...The time for talk is over. The time for action is now, because we know that if we do not act, a bad situation will become dramatically worse. Crisis could turn into catastrophe for families and businesses across the country.

And I refuse to let that happen. We can't delay...

It seems to me that the President suffers from what psychologists call an "action bias." Washington Post columnist Shankar Vedantam described the "action bias" like this early last year:

The action bias, or the desire to do something rather than nothing when you have just been through a terrible experience, plays a powerful role in our lives. It influences individuals and companies, investors and leaders. You can see the action bias on display in current thinking on the housing and economic crises, in the bitter debates over the war in Iraq -- even in discussions about how to fix a football team that's a perennial loser.

When people suffer losses and confront the possibility of even greater reverses -- it doesn't matter if you are talking about a terrorist attack or a meltdown in retirement savings -- it is psychologically difficult to do nothing, to hold course. This is true even when the action you contemplate produces an outcome that leaves you demonstrably worse than you were in the first place.

Physicians take an oath that says "First, do no harm," and this should be the controlling philosophy behind any legislative attempt to steer the economy one way or another.

The President should read the latest report from the non-partisan Congressional Budget Office (CBO), which says that, if the Obama plan is passed, it will lead to some short-term gains at the expense of long-term economic pain. The plan (encompassed by H.R. 1, the House bill) would reduce Gross Domestic Product over the next decade.

The CBO's report, done in response to request by Commerce Secretary-designate Judd Gregg, now a senator from New Hampshire, states:

Most of the budgetary effects of the Senate legislation would occur over the next few years. Even if the fiscal stimulus persisted, however, the short-run effects on output that operate by increasing demand for goods and services would eventually fade away. In the long run, the economy produces close to its potential output on average, and that potential level is determined by the stock of productive capital, the supply of labor, and productivity. Short-run stimulative policies can affect long-run output by influencing those three factors, although such effects would generally be smaller than the short-run impact of those policies on demand.

In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some provsions—such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislation’s budgetary cost. Including the effects of both crowding out of private investment (which would reduce output in the long run) and possibly productive government investment (which could increase output), CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net.

This analysis should come as no surprise to anyone who is economically literate. The stimulus package is a shell game. It just moves money from one sector of the economy to another, based on political rather than market criteria. It has no overall positive effect.

Putting it another way, syndicated columnist Walter Williams quoted George Mason University economist Richard Wagner in a recent article:

“Any so-called stimulus program is a ruse. The government can increase its spending only by reducing private spending equivalently. Whether government finances its added spending by increasing taxes, by borrowing or by inflating the currency, the added spending will be offset by reduced private spending. Furthermore, private spending is generally more efficient than the government spending that would replace it because people act more carefully when they spend their own money than when they spend other people’s money.”

Williams, who also teaches economics at GMU, then expands on the point in his own colorful way:

Let’s say that Congress taxes you $500 to put toward creating construction jobs building our infrastructure. The beneficiaries will be quite visible, namely men employed building a road. The victims of Congress are invisible and are only revealed by asking what you would have done with the $500 if it were not taxed away from you. Whatever you would have spent it on would have contributed to someone’s employment. That person is invisible. Politicians love it when the victims of their policies are invisible and the beneficiaries visible. Why? Because the beneficiaries know for whom to vote and the victims do not know who is to blame for their plight.

In stimulus package language, if Congress taxes to hand out money, one person is stimulated at the expense of another, who and is unstimulated. A visual representation of the stimulus package is this:

Imagine you see a person at work taking buckets of water from the deep end of a swimming pool and dumping them into the shallow end in an attempt to make it deeper. You would deem him stupid. That scenario is equivalent to what Congress and the new president proposes for the economy.

A far more important measure that Congress can take toward a healthy economy is to ensure that the 2003 tax cuts don’t expire in 2010 as scheduled. If not, 15 separate taxes are scheduled to rise in 2010, costing Americans $200 billion a year in increased taxes. In the face of a recession, we don’t need that.

Given that the recession (which began in December 2007) is already half over -- the average length of recessions is 18 months, though some extend to 24 months -- the best prescription is to do nothing and let the economy sort itself out through market forces.

Writing in Politico on January 28, reporters Eamon Javers and Jim Vandehei noted:

Most of Washington has reached quick consensus: Government must do something big to shock the economy, and it should cost between $800 billion and $900 billion.

But dissident economists and investment professionals offer a much different take: Most of Washington is dead wrong.

Instead of fighting over what should go in the economic stimulus bill, pitting infrastructure spending against tax cuts and contractors against contraceptives, they say lawmakers should be fighting against the very idea of any economic stimulus at all. Call them the Do-Nothing Crowd.

“The economy was too big. It was all phantom wealth borrowed from abroad,” says Andrew Schiff, an investment consultant at Euro Pacific Capital and a card-carrying member of the stand-tall-against-the-stimulus lobby. “All this stimulus money is geared toward getting consumers spending and borrowing again. But spending and borrowing were the problem in the first place.”

Javers and Vandehei report, correctly, that

government stimulus plans have a long history of failure. Remember last February’s $168 billion economic stimulus package? President Bush called it “a booster shot for our economy” and promised that it was large enough to have an effect. It wasn’t, and it didn’t work.

Citing a Cato Institute scholar, Javers and Vandehei continue:

For the Do-Nothings, the argument isn’t about economic nuance, it’s about right and wrong. They say that borrowing more money to finance a stimulus package will pass a crushing and possibly permanent debt load on to the next generation. “The question is,” says Chris Edwards, the director of tax policy studies at Cato, “is this morally proper?”

Edwards says no. “Policymakers are saying: ‘Screw the future generations.’”

The Do-Nothing Crowd also points to some of the hidden upsides of the recession — developments they say are already helping position the U.S. economy for a recovery.

Finally, they quote a Nobel laureate who is resigned to wrong-headed government action even though inaction is preferable:

Nobel Prize-winning economist Edward Prescott of Arizona State University agrees. “Congress has to do what people want, and it’s clear that the people want this stimulus,” Prescott says. “But I just wish the people would tell them: ‘Don’t do it.’”

People still can tell their Senators to vote no. If they're not already drunk with power, those legislators might just listen.

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