Deconstructing the "Stimulus" Doctrine
August 26, 2016
Barack Obama's first major initiative as president -- even before Obamacare -- was his economic "stimulus" plan. At that time, businessman Donald Trump praised Obama's plan while Obama's defeated opponent in the Democratic primary race, Senator Hillary Clinton, had proposed her own "stimulus" plan to compete with Obama's.
Fast forward eight years and we find that presidential nominees Trump and Clinton remain enthusiastic endorsers of government "stimulus." Both propose to spend hundreds of billions of dollars on an "infrastructure and jobs program" that seems patterned after President Obama's $800 billion "stimulus plan."
The fixation on the idea that government can somehow stimulate the economy is a dismaying prospect. Government "stimulus" is a fallacious economic doctrine that has evolved into an entrenched political dogma in spite of the fact that government stimulus programs fail to accomplish what they promise. The continued advocacy of such failed policies is sheer quackery. In the following paragraphs, I will deconstruct and debunk the stimulus doctrine/dogma on both theoretical and historical grounds.
Keynesian Stimulus Basics
John Maynard Keynes set forth the theoretical basis for "stimulus" in his 1936 book, The General Theory of Employment, Interest and Money. Most of you are at least somewhat aware of his theory: Economic sluggishness manifest in struggling businesses and unemployed workers, happens when consumers don't spend enough. Keynes dubbed this malady an insufficiency of "aggregate demand."
The Keynesian prescription was that government should remedy the undesirable condition of inadequate aggregate demand by adopting policies designed to increase overall spending, thereby boosting aggregate demand, to compensate for the supposed deficiency of private sector spending. Government could accomplish the goal of "fixing" the economy by deliberately incurring budget deficits through some combination of increased government spending and lower taxes on the private sector. That is Keynesian "stimulus" in a nutshell.
The notion of insufficient aggregate demand -- that consumers are not buying enough -- is presumptuous and arbitrary, an opinion utterly devoid of scientific content. Who is to say that consumers are making wrong decisions about what and how much to buy and not buy? What should they be buying? Do government "experts" know better than the people themselves what the people want (Hayek's "pretense of knowledge")?
In a private property-based market economy, where the consumer is sovereign and producers prosper only to the extent that they provide value to consumers, price signals continually recalibrate, readjust, and reconfigure production so as to cater to consumers most highly ranked values. If government officials and planners could do a better job of coordinating production than the price system does, then wouldn't the whole world have adopted socialism by now?
Economically speaking, there is no "right" amount of aggregate demand. In fact, aggregate demand doesn't matter at all. What is economically crucial is the specific and relative demand for the myriad goods in the marketplace. When demand for certain goods and services decreases, consumers are signaling to producers that they don't want more at the current price. Producers need to lower their asking prices if they want sales to pick up.
If producers can't operate profitably at lower prices, the market is signaling that producers need to switch to producing different goods and services that consumers value more highly. Consumers may prefer different consumer goods in the present, or they may be content to forego present consumption in favor of future consumption. In the latter case, savings will gravitate toward the production of capital goods devoted to longer-term, more roundabout processes of production.
Prices coordinate production, both in the present and inter-temporally. When government boosts spending to jack up aggregate demand, it interferes with the market's price signals and so discoordinates production by artificially altering patterns of production. Such distortions are not instances of "market failure," as Keynesians, socialists, and progressives like to claim, but the result of political interventions that subvert and suppress markets' natural self-adjusting processes.
First, let's take government spending. To say that increasing government expenditures stimulates production and adds to a society's wealth is mistaken. Government spending is inherently political, not economic. Under a so-called "stimulus plan," producers make more of what government tells them to make, and less of what consumers prefer, thereby making consumers poorer than they otherwise would be. Nobody denies that when government channels additional funds into a certain industry as part of a so-called "stimulus" plan, activity in that industry increases. However, that doesn't "stimulate" the economy as a whole or increase the overall wealth of society.
This point is difficult for many to grasp. Everyone can see the workers and other inputs that are employed by government spending, and so they conclude (mistakenly) that there would be even fewer jobs and production were it not for government. What they can't see are the jobs, business, products, and services that would have been produced in response to consumers' more highly valued preferences, as communicated through the economic language of market prices, had government not boosted spending in certain, politically determined directions (e.g., Solyndra, bridges to nowhere, "shovel-ready jobs," etc.)
Look at it this way: if Uncle Sam gave you or me a billion dollars to spend, we could put a lot of people to work and buy a lot of other inputs. The problem is that unless we are talented enough entrepreneurs to discern what people value most highly and are able to serve those wants profitably, we will reduce the net total of wealth in society by producing things that people value less instead of letting the inputs we use be employed in the production of what people value more.
Keynes and his latter-day followers either don't comprehend or don't care that production for production's sake-- such as for the purpose of increasing "aggregate demand" -- instead of in response to the price signals that show what consumers value most, inevitably will impair efficiency and so subtract from society's wealth. That is hardly what you would call an economically beneficial policy.
How Tax Cuts “Stimulate” the Economy
While Keynes was wrong about government spending stimulating genuine, overall economic growth, he was a good enough economist to understand the positive economics effects of tax cuts. More specifically, reductions in key marginal tax rates give rise to increased wealth production and higher standards of living overall as the Harding/Coolidge tax cuts of the 1920s, the Kennedy/Johnson tax cuts of the 1960s, and the Reagan cuts of the 1980s all demonstrated. It still isn't correct, however, to say that tax cuts "stimulate" the economy. The "stimulus" verbiage makes it sound like government itself provides the fuel that propels economic growth.
Entrepreneurs, businesses, and workers produce a society's wealth. Taxes impede that process by imposing economic burdens on entrepreneurs, businesses, and workers. Tax cuts reduce the impediments to wealth creation, which is economically beneficial. However, tax cuts don't mean that government has become a positive producer of wealth, but rather that it "helps" only by crippling economic production less. Government isn't stepping on the economic gas pedal, so to speak; it is merely lightening its pressure on the economy's brakes.
Picture someone trying to walk five miles carrying a 100-pound weight. If you reduce the weight to 50 pounds, the walker will make better time. The burden is not as heavy as it was before, but it still isn't as light as it would be if the burden were reduced further or eliminated completely. Today's tax rates -- needed to fund myriad government wealth-transfer programs -- represent a heavy burden saddled on our hypothetical walker.
So, here is the bottom line: It is misleading to characterize tax cuts as an economic "stimulus," even though economic activity typically improves when taxes that act as economic disincentives are lowered. A more accurate characterization would be to say that tax cuts "liberate" economic activity by loosening government-imposed shackles. Thus, the key to President Reagan's successful economic policy mix was his tax cuts, and it would be more accurate to say that he implemented an economic liberation plan rather than an economic stimulus plan.
To summarize the theoretical flaws of the Keynesian doctrine of government economic stimulus, government cannot manage aggregate demand in an economically rational or helpful manner; government spending distorts markets, undermines their efficiency, and retards economic growth; and tax cuts that reduce disincentives to work, investment, and production promote economic growth by partially liberating wealth creation from political impediments to economic growth. Now let's look at history to see how Keynes' theory has worked in practice.
The Great Depression
The original "stimulus" programs were launched by Presidents Hoover and Franklin Roosevelt in the 1930s. They were the first presidents to try to assist economic recovery by massively increasing government spending and budget deficits. (FDR's lieutenants later admitted that the New Deal was nothing more than Hooverism on a grander scale.) Neither president pursued deficit spending because of Keynes, since Keynes' stimulus theory didn't appear until early 1936, although Roosevelt and his brain trust embraced Keynes for providing intellectual justification for significant peacetime deficit spending. Clearly, though, FDR's team didn't get the memo about cutting tax rates and, like Hoover before him, suppressed and bogged down economic activity with repeated tax hikes.
The fact is that neither Hoover nor FDR adopted a complete Keynesian policy mix in the attempt to ameliorate economic stagnation. Instead, both charged full speed ahead with theeconomically depressing part of the Keynesian program (i.e., huge increases of government spending) while failing to implement the economically helpful part (tax cuts). The Hoover/FDR debacle isn't a completely fair test of Keynes' theory since they implemented only part of it, but in the hands of American politicians obsessed with redistributing wealth like FDR and Barack Obama, the progressive political orthodoxy quickly became "stimulate the economy via deficit spending," with the tax-cut part of the theory falling neglected and ignored by the wayside. (Perhaps that is why Keynes himself ruefully remarked before his death that he himself was not a Keynesian.)
The historical record is unmistakable: The Great Depression was an economic disaster. It was the painful and natural result of first Hoover, then FDR, diverting production into uneconomic, wealth-sapping paths with their spending binges, while suppressing economic production through tax increases. Even FDR's own Treasury Secretary,Henry Morgenthau testified to Congress in May, 1939, "We are spending more than we have ever spent before and it does not work...I say after eight years of this administration we have just as much unemployment as when we started...And an enormous debt to boot!" (Note that Morgenthau said "eight years," even though Roosevelt had been president for only six at that time. He was acknowledging that the deficit spending tactic had started under Hoover.)
One would think that the Great Depression would have convinced any rational person that huge increases of government spending prolong rather than alleviate economic sluggishness. Alas, the opposite is the case. Other economists undoubtedly have different opinions, but the next real test case for the deficit-spending-as-economic-cure didn't happen until the presidencies of George W. Bush and Barack Obama.
Deficit spending in the 1940s was for the purpose of financing World War II. In the 1960s, it was to finance "guns and butter" -- Lyndon Johnson's simultaneous wars in Vietnam and against poverty. 1970s deficits were incurred to finance the expanding welfare and regulatory state. In the 1980s, the primary reason for deficits was Ronald Reagan's military buildup to challenge the Soviet Union and increased domestic spending demanded by Tip O'Neill and the Democratic House in exchange for the military spending. The 1990s was an economically strong decade that required no "fix" from Washington. After the turn of the century, though, deficit spending for the purpose of counteracting weak economic activity returned with a vengeance.
Keynesianism Under George W. Bush
The next major push for an explicit "stimulus plan" came during the second term of President George W. Bush. It's hard to say whether Bush was consciously pursuing a stimulus strategy throughout his presidency, but if nothing else, Bush's eight years showed that deficit spending resulting from huge spending increases don't produce a thriving economy. Federal spending soared by 50% in Bush's eight years -- the first six of those years with a Republican Congress -- and the consequent deficits were the largest in history (although those records were quickly shattered by his successor).
Indeed, in his last year in office, Bush's attempt at Keynesian stimulus was explicit. He promoted and secured passage of The Economic Stimulus Act of 2008, which gave tax rebates of up to $300 per person while continuing to increase spending. Those checks transferred money from the capital markets to consumers, distorting economic decisions and doing nothing to improve the incentives for wealth creation. The so-called "stimulus" failed to stimulate. (Incidentally, during his first term, after 9/11, Bush got Congress to pass supply-side tax cuts -- i.e., reductions in marginal rates that lessened disincentives on economic activity -- and those tax cuts were followed by a modest but noticeable pickup of economic activity.)
The Obama Stimulus Failure
The biggest test of the effectiveness of deficit-spending-as-economic-stimulus in modern times came from Barack Obama. Indeed, Obama's own words made it plain that the Keynesian stimulus doctrine had evolved into a rigid political dogma.
In his first economic speech, given just a few days before he took the oath of office in 2009, President-elect Obama averred, "Only government can provide the short-term boost necessary to lift us from a recession..." Obviously, Obama was (and remains) a true believer in government, instead of free market prices, as the driver of the economy, and so he jacked up Uncle Sam's annual spending by approximately three-fourths of a trillion dollars while relentlessly resisting tax cuts and pursuing additional tax revenues. The results of Obama's stimulus plan are well-known and undeniable: the weakest economic recovery from a recession in history.
In spite of that failure, four years later an unrepentant Obama still was getting his American history wrong, and continued to buttress his continued advocacy of government-as-economic-doctor with two egregious errors -- 1) that free markets can't fix a severe economic downturn (Obama needs to read Jim Grant's account of the"forgotten depression" of 1921 in which a rapid recovery from a steep economic slide happened in mere months after President Harding cut both taxes and government spending); 2) the strange belief that somehow the Great Depression proved that more government spending is the cure for economic stagnation.
The average American should find it scandalous and worrisome that Hillary Clinton (who offered her own "stimulus plan" as a candidate in 2008) still wants to follow in Barack Obama's footsteps and provide more government stimulus spending(combined, she says, with some targeted tax cuts that undoubtedly would increase the deficit even more). Has she not noticed the dismal performance of the economy under Obama's policies?
I explained in the first part of this article how the Keynesian stimulus doctrine was based on erroneous premises. In the second part, I have tried to show you the sad historical record of stimulus plans. The fact that the two biggest stimulus programs in history -- those of two bipartisan tandems -- Hoover/FDR in the 1930s and Bush/Obama in the most recent ten years of this century -- have resulted in the
Great Depression and Great Recession. What more proof do you need that the last thing the USA needs is another government stimulus plan?