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Monday, September 20, 2010

My Exchange with a Heritage Economist

I've been trying to figure out how conservatives such as Rush Limbaugh imagine that the stimulus actually caused the unemployment rate to increase and the economy to collapse. My book on Limbaugh will be coming out March 1, and so I wanted to look more in-depth into the craziness that is Limbaugh's belief that "the $787 billion 'stimulus' led to the loss of three million jobs."

So I decided to go to one of Limbaugh's advertisers, the Heritage Foundation, and found a macroeconomist on their staff, Karen Campbell, to ask her my questions:

Dr. Campbell: I'm a writer doing an analysis of the Obama Stimulus Plan, and I read your analysis online about the stimulus plan, and I wanted to get a quick response from you about your argument. Is your claim that the stimulus plan was misguided and largely a waste of money, or do you think it alone had a direct negative effect on the economy? Would you say that due to Obama-Pelosi-Reid's stimulus bill, we are losing millions of jobs?
This was her reply, in full:

Hi Mr. Wilson: My argument would be both; the government borrowed money from other places in the economy (and global economy) to spend it where it thought it might be useful. Borrowed money must be paid back with interest and therefore borrowed money should be invested in assets (or projects to build assets) where the rate of return is greater than the interest. This way the borrowed funds and interest can be paid back from the income created by the investment rather than having to take from existing assets (dis-saving and depleting the capital stock) or in the government’s case charging the taxpayers more. If either of the latter has to happen then the economy is worse off. Further we can use a baseline created by forecasting company (whose business is too make accurate likely forecasts for the economy so businesses can make good decisions going forward) of the likely rate of rate return those borrowed funds would have gotten if lent to the millions of investors throughout the country who saw profitable investment opportunities in their area.

The baseline shows the jobs and goods and services produced by the labor and capital created and employed by these investments. Then we can say "what if" the government borrows the savings instead? How many jobs and goods and services would we have in the economy. This can tell us whether it is likely that the policy will be a net improvement. This is how we can get an estimate of jobs that were foregone (lost).

Not all stimulus spending is created equal again it depends on how the borrowed money is used and some might argue that investors in the private sector were not borrowing money and therefore the government had to borrow and invest for them. Unfortunately what we heard instead of invest was "spend for consumers who weren’t spending." Not only did we not invest, government now took on the role of the credit card happy consumer. This makes businesses and other investors (which is basically everyone who earns income and has savings and mutual funds in pensions, etc.) very nervous because they know that this borrowed money isn’t earning income and therefore they will be required at some point to ante up more of their income to pay off the debt. This causes them to hoard more cash and not take on long term risks (the very risks that are needed to recover and grow the economy.) These expectations triggered by the stimulus spending is a way in which the stimulus is also indirectly impeding jobs by imposing this large opportunity cost of foregone productive investments.

Interestingly we now have current proposals for more spending specifically for long term investments. Unfortunately I fear this is too late and, although theoretically the investments could earn a high rate of return; historical evidence has shown the political incentives for special kick-backs, overly lucrative government contracts, etc. tend to wipe out the efficacy of government "investment." It is better to allow individuals throughout the country to borrow and invest in projects they are willing to take a risk on (and therefore expect to gain a positive rate of return). This diversification of investment helps not only keep the economy overall more stable (we saw what happened when investment got concentrated in one area) and it helps spread the gains throughout the country so growth and development can occur in more even patterns (rather than patterned by, for example, politically important states. This is not cynicism but a reality of the incentives faced by the private and public sector and why it is so important for the public sector to maintain it’s governing role (referee and rule-making) and not create a conflict of interest by playing on a private sector team.)

I hope this helps clarify my argument. I’m sorry if it is a bit long winded. Thank you for taking an interest in my work and taking the time to email me. Please let me know if you any other questions.

Karen Campbell
I answered back to her:

Thanks for your detailed reply.

I am confused about one issue. There is a long-term critique of whether the stimulus was a good thing, and whether it will have a long-run beneficial effect on jobs and the whole issue of long-term benefits and costs.

But I was interested in the short-term effect, the fundamental question of whether the stimulus could have caused unemployment to rise and millions of jobs to be lost in the short term.

The only explanation you seem to offer is an expectations game. But it doesn't seem very plausible that nervous businesses are laying off millions of people because they expect taxes to be raised years down the road to pay for $800 billion in stimulus spending (which is a small part of the overall government debt). I just don't see how it's rational for a business to hoard money and avoid a profitable investment now because the government spent some money on the stimulus plan that eventually will have to be paid back by the American people.

Karen Campbell responded to me:

Actually the effect is not so much on existing businesses or existing business activity as it is on the potential. In normal times hundreds of thousands of jobs are created and destroyed each month. What we’re seeing now is that job losses are about the same as a normal recovery but jobs are not being created. New businesses are not starting up and existing businesses are not investing and expanding their businesses. My colleague, James Sherk, looked at the numbers here

When people are investing in safe government bonds to pay for spending that congress thinks will create jobs, they are not investing in riskier new businesses or financing new business expansions. Expectations play a large role but there is also the direct mechanics of moving financial resources from one sector of the economy to another (banks, as financial intermediaries for savers, lending to government versus lending to private sector individuals and businesses).

Also, just a note, I would not argue that the stimulus spending in and of itself caused millions of jobs to be lost. I think the stimulus spending would have depressed job creation but not to the extent that we are seeing. The continued rise in unemployment that we saw last year was a combination of many factors that increased the level of uncertainty. The government’s decisions to increase that uncertainty by implementing and trying to implement a number of unprecedented changes (which means businesses and individuals have no good method for calculating the likely costs of the policies and therefore are not able to make decisions about investments because of the extreme uncertainty of potential returns, is what is hindering the recovery and private sectors ability to employ underutilized resources in new and profitable ways.

Hope this is a little more clear?
The fundamental mistake Campbell is making, I think, is this assumption that government spending diverts money away from private investment. This is the "crowding out" effect. In the 1990s, it was argued that the Clinton Era's budget surpluses helped the economy by reducing the debt held by the government and allowing the private sector to borrow more. But that idea simply has zero relevance to our current situation. The government is borrowing lots of money, but it's able to print plenty of money and hand it out to banks without serious inflation. Private companies and banks are holding onto tons of cash right now, and it's not the case that government borrowing is depriving any businesses of loans they need. Instead, the problem is the reluctance of banks to loan money due to tighten lending rules and the reluctance of businesses to expand due to the global recession. As for "uncertainty," it's hard to identify any Obama action that increased economic uncertainty in any way that would actually reduce business activity.

But it is notable that Campbell refutes the Limbaugh theory that Obama's stimulus could have caused millions of jobs to be lost. So even the Heritage Foundation, the group that Limbaugh embraces as the experts on the economy, rejects Limbaugh's crazy economic theories.

Crossposted at Daily Kos.

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