How Not to Stimulate the Economy

By Steven Miller
  • Monday, December 10, 2001

The country is in recession and has been since March. At the same time we face a constant shadowy terrorist threat. The confidence of American consumers has continued to drop, and layoffs continue to grow.

Here in Nevada, tens of thousands of workers no longer have jobs. Indeed, the U.S. Labor Department reports that last month Nevada’s unemployment rate soared from 4.8 to 6.3 percent—an increase greater than that of any other state. At the same time, most leading private economists are predicting that the national economy will shrink even faster this quarter than the last. And the national economy is the foundation on which our state’s tourism economy depends.

So, given Nevada’s perilous situation, what sort of approach to stimulus has our senior senator been promoting from his No. 2 position in the U.S. Senate leadership?

Unfortunately, Sen. Reid’s policies actually are those likely to worsen our country’s current economic plight—and so also the economy of Nevada. Indeed, the particular nostrums that Reid has been pushing are of a type that have consistently deepened and prolonged American joblessness.

The senator, despite a well-nurtured Nevada image as a "fiscal conservative," has put his considerable power and influence behind a category of discredited economic quackery— Keynesianism—that has failed America every time it’s been tried.

Politicians often find the prescriptions of this doctrine—massive government spending—overwhelmingly seductive. The reason, of course, is that it gives them, personally, enormous power: They now get to dispense a big chunk of the nation’s economic resources. But for all the change it may make in the lives of politicians (and those of their hangers-on), government spending never in fact increases total employment. Actually, it tends to further reduce the efficiency of the economy—and so actually reduce the number of genuine jobs.

How the Depression was prolonged

The Keynesian approach—named for British economist John Maynard Keynes—had its most complete trial during the administration of Franklin D. Roosevelt. Though Keynes’ ideas were murky, and never entirely embraced even by their author, they were hailed as a way to slay the dread Depression dragon. "Priming the pump" was the metaphor used by FDR—the pump being the U.S. economy and the "primer" being billions of dollars borrowed by the government from the public till. The scheme seemed to work for a while—so long as government expenditures were gushing into the economy and America was spending itself deeper and deeper into debt. But the broken part of the "pump"—Americans’ desire to voluntarily invest—was not being fixed; indeed, it was being damaged even more. In 1941—after eight straight years of Keynesianism—U.S. unemployment was still over 10 percent. The job situation only improved with the coming of World War II as foreign governments entered the American economy, buying planes and other armaments with cash on the spot. Backing up these dollars? No government IOUs, but gold, already shipped from Europe and in Canadian or Federal Reserve coffers.

America’s next attempt to spend its way out of a slumping economy was in the 1970s, when the Nixon, Ford and Carter administrations all deployed redecorated Keynesian tax-and-spend policies. What the administrations got was economic stagnation and ever-accelerating inflation—the mixture soon christened "stagflation." Only the tax relief of Ronald Reagan, coupled with the return of monetary sanity at the Federal Reserve, helped the American economy climb out of the dumpster.

Case in point: Japan

Japan’s experience over the last decade is another cautionary tale that Reid should not ignore. Massive public-works spending has failed to pull Japan out of its decade-long slump—one triggered, reasonably enough, by a series of sharp tax hikes on capital that began in 1988. But increased government pork also worsened the situation by diverting resources from more productive private-sector uses to less productive public ones.

Massive government spending was, of course, one of Reid’s very first proposals after the September 11 attacks produced widespread recognition that the U.S. economy needed help.

"Reid advocates a variety of new spending programs," wrote Las Vegas Sun reporter Benjamin Grove in mid-October, "including multibillion-dollar transportation construction projects." Such projects, argued Reid in a letter to President Bush, would "provide sorely needed improvements to our infrastructure system while creating thousands of long-term jobs across the country."

Sen. Reid also argued in a partisan radio address December 1st for jacked-up unemployment compensation: "Unemployed workers need that money, ... and they will use that money immediately, spending it and in turn helping stimulate the economy."

In both instances, Nevada’s senior senator signaled that he has no idea how real long-term jobs are actually created. What he proposes may have humanitarian benefits, but it will not "stimulate the economy"—in other words, add to the net stock of jobs. Indeed, no change in government spending will produce any real uptick in the economy. The money is just moved from one set of pockets to others—from the purses and wallets of taxpayers or bondholders to the purses and pockets of, in this case, the unemployed.

How to produce a net increase in jobs

The only way to produce a net increase of jobs in the economy is to somehow induce investors to fund more new jobs. That means reducing the disincentives that keep investors from funding new businesses (or expanding good existing businesses).

What is the biggest disincentive investors face? It is the tax code. If tax penalties remain unchanged, investors won’t alter their behavior. They’ve already adjusted to the current set of incentives and disincentives in the tax code. So to get them to invest (and risk) more, some new and stronger incentives must enter the picture.

This was the logic behind the three major tax-cutting periods of the 20th century. Each occurred during economic slowdowns and resulted in economic growth. During the 1920s, taxes were cut three times in response to a sluggish economy. The result was that from 1920 to 1929 the economy grew at 4.3 percent. The next big growth decade was the 1960s, following the Kennedy tax cuts. The third great economic expansion of the century unfolded after the Reagan tax cuts of 1981, which reversed nearly a decade of high inflation and dismal or negative economic growth. And all those troubles stemmed from Washington’s embrace for the government-spending gospel that Reid now wants followed.

If Sen. Reid’s prescription were, as he suggests, the road to prosperity, any number of giddy, profligate governments around the world would always be rolling in wealth. As it is, they end up panhandling before the World Bank.

Nevada’s unemployed workers want their jobs back. Their senior senator should do better by them.

Steven Miller is a policy analyst with the Nevada Policy Research Institute.

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