Why stimulus policies don't work, and why the 2013 outlook is dark

 

Recent economic news has been dismal: Unemployment remains stubbornly high, European economies spiral downward, stock-market investors become more nervous, and to add more turmoil, politicians spawn a “fiscal cliff” for January 2013.

Meanwhile, White House officials continue to misdiagnose the suffering patient by suggesting more of the failed policies – additional stimulus spending, more monetary easing and ever more costly regulations.

Economists generally agree that a fiscal stimulus policy consists of two elements. The first is a deficit-spending effort, especially on consumption; the second, an emphasis on providing private incentives (tax relief and reduced regulations) to spark risky, private investment (e.g., the purchase of durables and working capital), which are crucial towards making the stimulus effective. By increasing employment and gross domestic product, it prompts the feedback to sustain both further consumption and economic activity.

 

PRESIDENT OBAMA has made progress on the first need. During the past three years, more than $1.5 trillion have been expended on such programs. But he has grossly failed to meet the second requirement – a tax and much reduced regulatory environment (which, of course, should be considered at all times). But he implicitly believes that existing taxes and threats of rising taxes do not deter private investment. This is tragically naïve.

Upon Obama’s election, White House followers of economist John Maynard Keynes instituted three years of stimulus spending on the grounds that “a larger deficit boosts economic growth by increasing aggregate demand.” The results have been abysmal. The explanation is clear: The temporary increase in aggregate demand provided by the stimulus is not sustainable without incentives to increase private investment.

In short, the second action, which is as important, if not more than, the first requires vigorous White House leadership, which was and continues to be sorely lacking.

 

THIS CRITICISM applies as well to implementing monetary policy. If supportive tax and regulatory policies for investment are not in place, a monetary policy that makes it easier for firms to borrow, by making more resources available to banks as well as rock-bottom interest rates, can hardly stimulate private investment.

Thus, Obama’s failure to provide incentives for investment not only undermines his fiscal stimulus effort, but the Bernanke-Fed policy of monetary ease as well!

Economists firmly agree that if the consumption stimulus policy is to be sustainable, it must generate private investment. However, investment opportunities must be thought of, created, and developed by imaginative innovators. To help induce such investment, government policy must provide for the development of investment incentives, for “animal spirits” to be unleashed.

 

OBAMA HAS not only failed to provide such an environment, he also has taken the further incentive-destroying step of threatening to raise taxes and, just as oppressive, added more regulatory choke holds on the functioning of a free market.

To explain, profits to entrepreneurs from new ventures have two features: (1) the expected profits and (2) their riskiness. Investments with high expectations and low risk are most favored. But Obama’s policies, with their aggravating punitive threats, reduce expected returns and enhance the risk of projects – thus placing a huge dampener on adopting risky investments.

And that is not all. Even some environmental protection policies have the effect of discouraging new investments. Over the past three years, investments foregone to satisfy new environmental restrictions, and threats of new ones, must amount to trillions of dollars – the recently rejected Keystone XL Project comes to mind as an alarming example of this deplorable policy.

The most effective procedure for using deficit spending to spark both private investment and job creation is by cutting both personal and corporate taxes, not by bludgeoning risk-takers with overt threats of higher taxes and costly new regulations (currently running at the rate of 1,100 pages per day.)

 

INSTEAD OF enacting such measures, White House pronouncements have become perverse: Threats to increase taxes to serve the emotional need of envy have become increasingly shrill, and the wholly thoughtless Dodd-Frank financial regulatory bill was enacted along with an oppressive Affordable Health Care Act – and all these needless impediments on top of an onerous Sarbanes-Oxley Act.

Some Keynesian followers believe that since the trillions of dollars spent on stimulus spending have bombed, the appropriate policy should be to double, or even triple, such spending. Such an addendum suggests that a consistent failure of stimulus spending enhances confidence in the validity of the underlying theory!

This is, indeed, strange logic: The greater the quantity of evidence against a view, the greater the confidence we should have in its reliability, or in the soundness of a new, different theory which calls for out-of-sight expenditures in hopes of bringing a recovery. Before embarking on this extravagant venture, we should demand compelling evidence of the theory’s validity. After all, isn’t “the proof of the pudding in the eating”?

The consequences of these Obama failures are tragic, not only in the short run but for the long haul. The absence of a vigorous investment stimulus policy during the past three years is unforgivable, but the complete paralysis that these failed policies promise for the next six months foreshadows a dismal year for 2013.

 

INCOME AND employment growth in early 2013 depends on risky investment spending undertaken today. This lack of incentives, coupled with the absence of significant current investment, marks the proverbial canary in the coal mine. Unfortunately, the die has been cast for an unpleasant forthcoming year, regardless of which political party wins the fall elections.

In sum, rather than emphasize consumption stimulus, Obama should stress investment stimulus, which requires great emphasis on investment incentives, the critical factor in a sustained recovery. Ironically, we are willing to suffer a deficit to hopefully stimulate consumption, but unwilling to incur a tax-reduction-driven deficit to stimulate private investment, which promotes sustainable consumption, increased output, increased employment and more entrepreneurs like Steve Jobs.

 

(The writer is a professor emeritus of financial economics from the University of Georgia. He lives in Aiken, S.C.)

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