Debating the Stimulus
Avoid the GDP distraction.
SEPTEMBER 06, 2012 by STEVEN HORWITZ
With the election season in full swing, we can expect economic issues to be at the forefront of the candidates’ efforts to define their differences with each other. One issue sure to be under the microscope is the effectiveness of President Obama’s stimulus program. Here are some thoughts about the coming debate.
First, let’s admit the problem: We cannot conduct experiments in economics. The argument over the stimulus is a battle of counterfactuals. Obama’s supporters argue that without the stimulus things would have been much worse, while the critics will respond that the stimulus made things worse than they would have been without it. Because in both cases the comparison is to something that did not happen, there’s no way to settle that debate based on “the facts.”
The closest thing we have, and it’s far from ideal but important nonetheless, is the famous chart that accompanied the administration’s case for the stimulus in late 2008. The chart shows the Obama team’s predictions of, first, the unemployment rate over several years if the stimulus passed and, second, of the notably higher rate if it did not pass. The updated chart superimposes the actual unemployment rate over that period–a rate quite a bit higher than the administration’s prediction of what would have happened without the stimulus. Again, that chart is helpful but not definitive.
Another point that defenders of the stimulus raise is that since GDP in the fall of 2008 was shrinking 9 percent on an annual basis–which is Great Depression territory–the stimulus should be credited with at least stopping that decline: GDP recovered shortly after the spending started. The problems here are multiple.
First, GDP during the Great Depression shrunk so much because both the Federal Reserve and the Hoover administration made a number of mistakes by intervening to stop the original recession. Between the Fed’s mishandling of the money supply and the Hoover administration’s efforts to prop up wages, spend money on public works, and lend to farmers, homeowners, and businesspeople (all of which add up to “stimulus”), unemployment skyrocketed and GDP fell through the floor.
Pointing to the decline in GDP as the reason for Hoover’s expansion of government and Franklin Roosevelt’s New Deal–rather the initial cause of the Great Depression and the reason for its persistence–is to misunderstand the history. The Great Depression was a great depression because of government intervention, not despite it.
Second, of course government stimulus programs increase GDP: Government spending is counted in GDP, so the real challenge is not merely to increase it. The essence of a recession is a decline in business investment, as economists have argued for over 100 years. The challenge of a recovery is to get the private sector investing again. However, even that isn’t quite right because not just any old private-sector spending will do the trick: The spending has to create a sustainable pattern of resource use. Because politicians lack market information and incentives, government policies favoring one type of private-sector investment over another will simply create new patterns of malinvestment that will lead to another bust down the road.
The singular focus on GDP diverts our attention from the real problem, which is not the size of the economy but how well the pieces of the economic jigsaw puzzle fit together. An unfortunate legacy of the economics of the interwar years is that measurement became the hallmark of allegedly “real” social science and Keynesianism took what could be measured and built models to match. But what’s convenient to measure is not necessarily what matters. To the degree the stimulus debate is couched in terms of boosting GDP, it allows largely meaningless aggregates to paper over the microeconomic coordination on which economic growth depends.
The advocates of stimulus also conveniently ignore the degree to which recessions before the Great Depression corrected themselves without a stimulus. Yes, those recessions could be fairly deep, though none even half as deep as the Great Depression, but they were remarkably short. Recovery came briskly and completely. That history, along with the ways intervention turned a recession into the Great Depression, gives us reason to believe that the current lagging recovery is simply the result of bad policy.
As the debate over the stimulus continues into November, classical liberals should be aware of all these issues.