Saturday, August 11, 2012

Fiscal policy is the use of government spending and taxation to influence the economy. Increases in government spending can create jobs that are needed to produce the goods and services the government buys, and then some through what are called “multiplier effects.” Reducing tax rates, to businesses and people, gives them more disposable income to spend. The more goods and services they buy, the more people that will be needed to make those things. That’s it in a nutshell.

Unfortunately, as the old saying goes, “The Devil is in the details.” Depending, for example, upon precisely who benefits from a lowering of personal tax rates, that extra disposable income could be used to pay down credit card or other debt and/or for savings – in which case those lower taxes won’t generate any new consumer demand. It’s not that paying off debt and saving some money aren’t important. It’s just that neither has any immediate impact on employment. Reducing corporate tax rates or giving companies tax credits for hiring are “supply-side” concepts that only work only if management believes that it can actually sell the additional products it makes or the expanded services it ramps up to provide.

During the Great Depression in the 1930s, unemployment rates rose to as high as 24.9% in 1933, and then fell, over the next seven long years, all the way to 14.6% in 1940, the year before we entered World War II. In 1941 the unemployment rate fell to 9.9%, then 4.7% in 1942, 1.9% in 1943 and 1.2% in 1944. It then rose to 1.9% in 1945, the year the war ended – still way below the usual definition of “full employment” which is roughly 4%. The unemployment rate in 1946, the year after war ended, was 3.9%.

Make no mistake about it, what ended the Great Depression was World War II and the immense level of sustained government spending that war engendered – injected into an economy that was much, much smaller than the one we have today. In 1945 dollars, the United States spent $341 billion on World War II, the equivalent of $4.1 trillion today. That’s right. Over five years we injected $341 billion into an economy with GNP (Gross National Product) of only $113 billion in 1940 that grew to $240 billion in 1947, after the war. $240 billion is chump change by today’s standards. Needless to say, there is no current era, peacetime equivalent of an economic stimulus program that large relative to our economy. Our current GNP is $15.6 trillion, with a “t.”

Make no mistake, the current recession is a much smaller economic event than the Great Depression. It doesn’t make any difference. Even on a proportionate basis, we’re not going to spend anywhere near what it would take to accomplish a recovery as a result of gross, untargeted government expenditures. Even if we knew how to spend all that money, we can’t afford it. The relatively little we can spend could have a significant impact only by encouraging, but not outright effecting, a recovery. To be effective, fiscal policy has to be properly “targeted” – a concept we’ll talk about in the next article in this series. President Obama’s stimulus programs have been anything but. They have been gross, misdirected, poorly designed and, no surprise, generally ineffective.

The problem is that President Obama, so far, has chosen to squander a substantial portion of the stimulus dollars he spent to prop up specific companies, including General Motors and AIG. His thinking was that these entities were “too big to fail,” that their demise would make an already bad situation unacceptably worse. Unfortunately, this is a strategy that demonstrates a lack of understanding of how the economy, and business in particular, works. Long story short, he doesn’t trust capitalism.

For one thing, even if General Motors had failed completely, literally closed its doors through a Chapter 7 bankruptcy, one or more other companies would have stepped up to fill the void. General Motors may have been suffering financially, but it was still selling cars. That demand for GM products would have gone somewhere, taking with it jobs for the employees needed to make those vehicles. Even with the billions we gave General Motors, jobs were lost. All President Obama did was make us an investor in bankrupt company that the economy, left well enough alone, would have restructured more efficiently.

It’s not clear, in other words, and not even likely that the billions we invested in General Motors saved any jobs compared to what would have happened had the government stayed out of it and left the economy, well enough alone, to take care of business. Anybody, the President in particular, who tells you otherwise, has no basis for making the argument that government money did what the economy was never given a chance to do. Better to have let General Motors go out of business and spend our money helping its employees transition to the companies who would takeover for GM, if necessary.

Likewise, if he hadn’t invested in AIG, it may or may not have gone out of business. One way or another, it would be a different company, smarter and more efficient, having been given no choice but to shed its more risky, less profitable practices. Instead, the President’s investments had the effect of excusing the poor behavior of a major financial sector firm without effecting any significant improvements in the design and function of that firm and the markets it serves.

The point is that the President has a religiously obsessive belief in the efficacy of government and doesn’t trust capitalism. It’s only human nature. Capitalism isn’t perfect, and none of us feels comfortable trusting what we don’t understand. Unfortunately, fiscal policy – limited government spending (directly and though reduced taxes) for the purpose of stimulating recovery – only works if you understand and believe in a free market economy.

More to the point, all those billions President Obama gave to just a handful of large companies to prevent further lay offs, so he believes, could have been better spent across the economy to help the un- and under-employed go back to work and to return their family incomes to where they were before the recession.

Even the stimulus programs that gave money directly to families and businesses suffered serious design flaws that, predictably, resulted in their failure to accomplish the President’s objectives.

It’s simple. The most profound ideas usually are. Capitalism and democracy are complementary forms of the economy and government. One can’t exist without the other. You can’t be an effective President of a democracy unless you have a basic understanding and appreciation of capitalism. You can’t frame and implement effective fiscal policy unless you do.

So, what exactly should the President and Congress be doing to stimulate a recovery? Relax. Did you think I’d just criticize and run? Not my style. Stay tuned. I have some specific suggestions, two actually, that we’ll talk about in the next installment in this series.

-Next Contestant

The entire series:
Part 1: The Magnificent Seven
Part 2: The Impotence of Monetary Policy
Part 3: Why don’t President Obama’s fiscal policies work?
Part 4: What’s wrong with tax-related fiscal policies?
Part 5: What can we do to encourage a recovery?