As Congress rushes toward enacting a fiscal stimulus plan, panelists hosted today by The Heritage Foundation and the Club for Growth warned that the massive spending bill was likely to delay economic recovery, misallocate resources, slow economic growth, and increase political corruption.
Historian Burton Folsom Jr. warned the audience that the political consequences of increasing the size of government may be just as troubling as the economic consequences. Folsom pointed out that the Keynesian-inspired economic policies proposed by the Obama administration have much in common with the New Deal policies of President Franklin Roosevelt. Roosevelt’s policies, said Folsom, were successful in at least one sense: Increasing the flow of resources controlled by the federal government allowed Roosevelt to distribute benefits to the political constituencies that Roosevelt and the Democrats needed in order to win re-election. The New Deal, said Folsom, gave Roosevelt the tools he needed to cement together a permanent Democratic majority, even as it failed to bring employment back down to pre-Depression levels.
The Heritage Foundation’s J. D. Foster pointed out a contradiction at the heart of the Keynesian design. The defenders of the stimulus plan argue that the collapse of credit is caused by the “idle savings” of fearful investors. Supposedly more government spending will solve that problem. But, asked Foster, how will making the government more fiscally irresponsible increase the confidence of investors in the U.S. financial system? In fact, said Foster, more spending and borrowing would only crowd out private investment.
Arnold Kling made a similar point. He argued that in risky times such as these, the correct policy to rebuild investor confidence is to minimize uncertainty. But a massive infusion of new government spending increases uncertainty because it increases the possibility that investors will lose confidence in the ability of the United States government to pay its bills. Kling argued that in a capitalist system, profits are the key to recovery. Profits and losses are the signals that tell businesses to expand or contract and we are not going to get new investment and new hiring unless businesses are making profits. Yet, the government, observed Kling, seems intent on ignoring market signals—in particular the signals that the financial sector should become smaller. Kling believes that cutting the employer portion of the payroll tax by 50 percent would be a much better stimulus than increasing government spending. Such a move in a time of slack employment, said Kling, would encourage businesses to expand hiring. This policy, he noted, has the advantage of using market signals for deciding where new jobs and resources should be allocated, which is much superior to relying on government spending to find the worthwhile projects. A related problem with government spending, noted Kling, is that the government is unlikely to be able to find a good fit between the jobs it creates and the jobs for which the recently unemployed are suited. Will we see, Kling asked rhetorically, Wall Street bankers driving bulldozers on highway projects?
Mario Rizzo argued that stimulus spending by and large amounts to throwing good money after bad. The market now reveals misallocations of resources that arose because of low interest rates. But, said Rizzo, political considerations will lead the government to allocate new spending to propping up those very sectors where adjustments should occur. Employment created by government spending, argued Rizzo, will not last once the fiscal stimulus ends, as eventually it must. Rizzo favors reductions in marginal tax rates as “neutral stimulus”—i.e, stimulus that does not continue to misdirect resources, but rather makes use of consumer preferences to guide new investment.
Luigi Zingales argued that any government intervention in the economy should be guided by clear principles about how the proposed intervention can fix a problem that the market cannot fix. Zingales said the stimulus bill clearly fails this test as well as costs taxpayers a lot of money. One problem that intervention might be able to fix, said Zingales, is dealing with the fact that homeowners with negative-equity in their homes have an incentive to walk away, and the securitization of that debt makes it impractical for any renegotiation of the debt to occur. Zingales reviewed the details of a proposal that he has made previously to solve this problem: Congress should pass a law making a re-contracting option available to all homeowners living in ZIP codes where the value of housing has fallen by 20 percent or more. That would actually save the banks money, Zingales explained, because recovering a house usually yields far less for the banks than the value of the equity that the homeowner lost when he walked away. A similar idea, said Zingales, can be put into place to shore up the failing banking system. Pre-package bankruptcies, argued Zingales, would put the banks back on their feet and allow them to start lending again without any cost to the taxpayer.
Heritage’s Bill Beach concluded the panel discussions by observing that there are two competing ideas on how to promote economic growth: lowering marginal tax rates on productive activity or giving consumers temporary incentives to go out and spend. Those ideas, said Beach, have already been tested. In 2003, President Bush’s proposals to cut marginal tax rates were passed and that lead to strong economic growth. On the other hand, the rebate checks from 2008 failed to boost consumer spending. Beach predicted confidently that by 2010, free market advocates will have won this debate. Given that economists and policymakers are still debating the New Deal that seems slightly optimistic. But we are certainly willing to hope.