President Obama announced a 3 year freeze on the discretionary part of the federal budget. Many liberal economists (including Paul Krugman) decried this as a wrong step. In an economic downturn the government should be spending and not cutting back. I agree in theory, but the question is does the theory apply in this case? I’m not going to go toe to toe with economists like Professor Krugman, but I will call out the news media for not addressing some basic questions here (and possibly not giving economists a chance to respond). Perhaps the media is shy to dive deeply into these issues because they’re complicated but let’s see if we can get educated via our Popsicle stick economy.
Initially our babysitting co-op was set up because the neighborhood was in a moderate economic down turn. Couples had money for the occasional night out, but not quite enough for a night out if they had to also pay a babysitter. Then someone had the idea of swapping babysitting duties with other families in the neighborhood and to keep track Popsicle sticks would be given for each baby-hour of sitting. Fast forward a few years and we rejoin our babysitting co-op in the middle of a deeper economic downturn. Families now don’t have enough spare cash for a night out even though the babysitting is “free” (paid for through the co-op). Our “keeper of the Popsicle sticks” who we call Paul (in honor of Krugman’s article) is blind to these problems in the real world. All he sees is a sudden dearth of activity of families buying and selling babysitting services. Last time this happened it was because there weren’t enough Popsicle sticks in the economy. Adding some sticks really jump-started the babysitting economy. So he tries that again here, but nothing happens. He’s puzzled.
What we’re trying to model is a lack of demand. In the earlier case where adding sticks stimulated growth there was pent-up demand for babysitting services. People wanted to use the service and were willing to work to do so. Adding sticks unleashed that demand (play the original simulation). Here though people can’t afford the cash part of the night out and so don’t want to use the service. Adding more sticks won’t help. We need to stimulate demand.
Stimulus could come in a few forms. We could imagine an increase in demand for babysitting services if we imagine a few families are unaffected by the economic down turn and can afford a night out but who also choose to use the babysitting co-op for their babysitting services. These “rich” families might temporarily invigorate the economy, but once the poorer families have a few nights worth of sticks saved up they probably won’t volunteer for additional work as they still can’t afford the main part of the date and so can’t even use the sticks they have.
A better stimulus would be to provide a product that most families would use. After all couples still want a night out, they just can’t afford dinner and a movie. But they might go for renting a movie and watching it with friends. Or the guys may go for a poker night while the women go for bridge night. To make such dates seem more like real dates the co-op decides to build a small common area in their neighborhood, big enough for several different couples to have a “date” (e.g. 4 rooms suitable for movie viewing/game playing each big enough for 2-3 couples). Access to the room will also be paid for by Popsicle sticks.
The Popsicle stick analogy breaks down a little here. The “stimulus” was the creation of the common building and that probably was paid for with real dollars not Popsicle sticks, but lesson is still valid. The economy is stimulated when dollars and demand are exist. If demand exists, add dollars. If dollars exist, create demand. If neither exist, supply both.
Following the Lessons of WWII
It wasn’t until after World War II that we fully climbed out of the Great Depression. Was WWII a government spending program? Of course it was, who else paid for all the military equipment and soldier salaries? Sure, we borrowed from ourselves (via war bonds) instead of from China, but it was government spending nonetheless. Those dollars made factories which made boats, tanks, planes, tents, uniforms, helmets, guns, bullets, and etc. After the war those same factories were easily retooled to create cars, trucks, radios, TVs, furniture, and etc.
Advocates of the stimulus package like to point out that WWII was a large stimulus program too. But here’s where the analogy to WWII breaks down. The Great Depression started in 1929, the US entered WWII in 1941 and WWII ended in 1945. So for either 4 or 16 years the American people did without. Either because the economy was depressed from 1929 through 1941 or because people sacrificed to support the war effort between 1941 and 1945 (or both). Four or sixteen years of living without created pent-up demand, a lot of it.
At the end of the war the “War Spending Stimulus” left us with companies that had factories which could make products people wanted and it left us with people who had money to buy those products. But as importantly these years of sacrifice left us with a lot of demand. But we don’t have 4 or 16 years to wait for demand to grow. We all want our economy back now. Besides growing demand is hard. Forecasting demand may be easier. We can see where our money is going today and we can forecast where our money may go tomorrow.
One example is energy. People are going to continue buying energy today, we should do what it takes to keep as much of those dollars in the US as possible. People are going to buy green energy in the future. We should do what it takes to be a player in that global market and not leave it all to China.
But let’s also keep in mind the other lesson from the “WWII Stimulus” and that is that we haven’t yet spent too much. The graph at the right shows this. A case could be made that the differences between then and now may mean that we shouldn’t let our debt grow to the same level as in WWII, but we’re still a far cry from that level and so we shouldn’t be unduly concerned with our current debt level.
All stimulus dollars puts money in people’s pockets. What we also need is increased demand and increased capability to meet that demand. We can’t create demand with stimulus dollars, but we can see where the future, what the demand will be then and seek to increase our capability there. We can also see what foreign demand there is and seek to tap into that. Projects that do these things are the best use of stimulus dollars.