Obama's Stimulus Delusion

With unemployment jumping to 10.2% in October, the highest level since 1983, underemployment reaching 17.5%, and the average weekly work week falling to a record low of 33 hours, the Obamaconomy is sputtering. Thus, it will come as no surprise that Obama is promising “to pursue further measures to create jobs.” Uh huh. Let’s talk about why the stimulus didn’t work and why Obama’s second stimulus will fail as well.

Why Stimulus Spending Never Works

Stimulus bills rarely work. Massive stimulus spending in the 1930s, 1960s, 1970s, and under Bush/Obama all failed to increase economic activity. Yet, liberals continue to love them. Indeed, it is a matter of faith among liberals, that federal spending can ignite the private economy by spurring demand. But you just can’t spend yourself to prosperity.

Liberals subscribe to something called Keynesian Economics. This theory, developed by John Maynard Keynes, holds that every dollar spent will result in a fivefold increase in GDP. For short term thinkers, which liberals are, this theory is manna from Heaven. But, as usual, they’re wrong.

Keynes’ economic theory relies on a little fiction called ceteris paribas, Latin for "all other things remaining unchanged." But in the real world, actions cause reactions, and it’s those reactions that Keynesians fail to consider.

Stimulating Consumer Spending ("Demand") Is A Bad Idea

The first goal of all Keynesian advocates is to stimulate consumer spending, i.e. demand. But this is a bad idea. If you stimulate spending by encouraging people to spend more than they otherwise would, you can get a short term boost -- Keynes is right about that -- but you create longer term problems. Indeed, every dollar a person spends today is a dollar they cannot spend in the future. So you are robbing the future to pay for the present. Moreover, if they borrow the money they spend, their overall ability to spend decreases by the amount of interest they must pay to get the loan.

So what you ask? Well that's what caused the current economic problem. The easy credit of the last decade allowed people to spend their future income at an alarming rate. Consumers were willing to do this because they believed they could tap the equity in their homes to cover their debts. Then housing prices fell. In response, consumers stopped spending because they became desperate to pay off their suddenly over-sized debts. Asking them to start spending again, simply will not work. It's irrational. . . it's like trying to avoid a hangover by staying drunk.

This, by the way, is why consumers used the Bush tax rebates to pay off debts, and why not all tax cuts generate a stimulus effect -- one time rebates (the only tax cuts Democrats like) are a bad idea.

Moreover, stimulus typically causes a misallocation of resources that can be catastrophic. For example, if we encourage people to buy cars today (see cash for clunkers), they will be less likely to buy cars in the future. If carmakers don’t understand this, they will respond to the increased demand today by ramping up production (like GM did). But when the sales fall again in the future, all of that extra production becomes a weight around the company's neck, which drags it down and can lead to a double dip recession following the second round of layoffs.

Further, by getting consumers to buy cars, government causes them to forgo other products that likely represent a better use of their money for them and for society. Indeed, whenever the government gets into choosing winners and losers, the result is always harmful.

Thus, while encouraging consumer spending (demand) can lead to a short term economic boost, the long term effects are quite harmful.

Government Stimulus ("Spending") Is An Even Worse Idea

It's even worse to have the government try to take the place of “missing” demand by going on a spending spree. In the example of a consumer spending a dollar, that dollar is something the consumer earned. But the government does not earn money, it takes it. Indeed, every dollar the government spends is a dollar taken from a consumer. Thus, while the government’s dollar can cause the same Keynesian effect as consumer demand, the act of taking the dollar from the consumer in the first place causes an inverse-Keynesian effect, as the dollar is taken out of the economy. In other words, by taking the dollar from the consumer, the government is cancelling out the stimulus effect it hoped to achieve.

Moreover, studies have shown that the government is simply not as effective in generating a stimulus effect as consumers are: it takes too long to spend the money and it goes to the wrong places. Which brings us to the Obamulus.

Why Obama’s Stimulus Was Worse Than Most

When the government spends money hoping for a stimulus effect, it usually aims for infrastructure projects. This is in part a nod to history, when our economy was based on such activities, a nod to unions, as such work is often unionized, and a nod to the idea that infrastructure is the one thing the government can buy that will benefit the greatest number of Americans.

Consistent with this, Team Obama promised massive amounts of infrastructure spending. In fact, the word “infrastructure” became almost a reflex to them whenever they mentioned the stimulus. Even now, when discussing the new "second stimulus" (actually third), Obama keeps hitting the “infrastructure note”:

“My economic team is looking at ideas such as additional investments in our aging roads and bridges, incentives to encourage families and business to make buildings more energy efficient.”

But the reality is rather different. Of the $787 allocated by the Obamulus, only $195 billion is targeted at what you or I would consider “infrastructure” projects, and most of those are boondoggles. The rest form a mixture of social spending and tax rebates, with the social spending going primarily to plug gaps in state budgets. None of that will generate any stimulus effect.

This point was highlighted when it was revealed that Obama’s “jobs created or saved” numbers were fraudulent. Remember Obama admitting that his jobs claim had been overstated -- that it wasn’t 750,000 as he claimed, it was really 30,383? There's more.

After this admission, Obama supporters conducted a new study, which they used to claim that actually 640,000 jobs had been saved. But the numbers don’t come anywhere near adding up. And many of these jobs were not actually saved. More than half of these jobs (325,000) were education jobs that were in no danger of being cut. For example, it was revealed the other day that 26,156 of the 100,000 jobs California claims were saved by the stimulus were California State University jobs that would not have been terminated even without the stimulus money. Those 26,156 jobs, by the way, are more “saved” jobs that were reported by 44 other states.

The Associated Press found that in one federal agency, pay raises for more than 7,000 jobs were counted as jobs saved. Many other “saved” jobs have been similarly exposed as falsified.

Moreover, as with all things political, the money was poorly distributed, going largely to the states that needed the least help. Indeed, a Wall Street Journal study found that states with the highest bankruptcy, foreclosure and unemployment rates got less money than better-off states. The study also found that higher income states received more money.

Thus, the money was not even spent where it would do the most good.

Is there reason to believe that a second stimulus would be any better? No. The problem here is that the Democrats fundamentally misunderstand the nature of economics.

Soon, I’ll outline a better way to do a stimulus plan.