How Capitalism Will Save Us (67 page)

O
ne reason Obama administration supporters give to justify their out-of-this-world stimulus spending is that a dollar spent by government isn’t just a dollar. Uncle Sam’s money, they believe, has a “multiplier effect.” The enormous flood of dollars into the economy not only helps recipients, it gets everyone moving.

In the Real World there’s a word for this: hogwash. In the case of the administration’s massive $787 billion stimulus spending, Obama’s economic advisers believe that the “multiplier” is 1.5; in other words, each dollar spent will generate a $1.50 increase in the gross domestic product.

Really? Economist Robert Barro is among those who believe spending has anything but a multiplier effect—just the opposite. His own research on the U.S. economy during World War II revealed that government spending resulted in less output and a lower gross domestic product. Every dollar spent by Uncle Sam resulted in only 80 cents being generated in GDP.

He concludes: “The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases and net exports—personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses—there was a dampener, rather than a multiplier.”
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Barro takes on the whole idea that government spending is a net plus for the economy:

Some people may ask at this point: What about all the activity that’s taking place as a result of all those government dollars flooding into the economy—going not only to the recipients of its largesse but to vendors, employees, and others who in turn spend and invest. Isn’t that helping people and having a positive effect? It may be helping some people, yes. But it does not ultimately boost the economy.

In
chapter 2
, we discussed how the “broken-window effect” described by the nineteenth-century French economist Frédéric Bastiat shows that fixing a broken window doesn’t create wealth. It may make jobs for the people who have to fix the tailor’s window. But the tailor is out the money that he used to fix the window, as well as the business he would have had if his shop had not been damaged. In other words, fixing the window does generate some activity, but for the tailor and the community as a whole, there’s a net loss.

Government spending fails to stimulate the economy because of the same broken-window effect. Spending may create jobs and economic activity. But at the same time, it drains capital from individuals and businesses, reducing the jobs and wealth that would have been created.

Dan Mitchell of the Cato Institute reminds us that “the federal government cannot spend money without first taking that money from someone.”
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That means siphoning off capital from the economy through either direct taxation or, perhaps later, the taxation needed to pay for government borrowing. There’s less money in the economy for private-sector investment. There’s less money available to put into new innovations, businesses, and jobs.

Not only that, there are additional costs. That’s because government spends money less efficiently than the private sector. The dollars are not allocated based on people’s needs in the Real World.

Government all too often ends up spending the money for political and not economic objectives. Like a $150 million airport built in a remote city that has only three flights a day. That almost no one uses except the powerful congressman who flies back and forth on its tiny commuter airline to his job in Washington. This is not a hypothetical example. Powerful Pennsylvania congressman John Murtha (aka “the King of Pork”) did this very thing. The John Murtha Johnstown–Cambria County airport may have generated construction jobs; it doesn’t help create future wealth. It’s a dead asset that sits virtually empty. Nonetheless, in 2009 it was slated to receive some $800,000 in “stimulus” funds.

Along with benefiting relatively few people, government spending on growing its own bureaucracy can drag down an economy by creating ever more costly market distortions. We’ve already seen the painful and costly consequences of domination of the health-care market by Medicaid and Medicare. Mitchell also gives the example of welfare programs that discourage work. He calls such outcomes a “behavioral penalty cost.”
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If there is a multiplier effect associated with government spending, he suggests, it’s this long-term negative impact on the economy.

Keynesians always justify spending with the rationale that spending mobilizes idle resources. It’s necessary during a downturn, they say, because consumers aren’t buying; businesses aren’t investing. However, government spending isn’t going to cure this. The only way to do so is to address the reasons behind the decline in activity.

That’s why stop-gap spending on initiatives like tax rebates always flops. Rebates typically produce a spike in consumer spending when the checks are issued—but little else. In 2008, as the economic crises deepened, the Bush administration sent out rebate checks—one-time payments of $600 for single filers, $300 per child, et cetera. The Obama administration sent out $250 checks to seniors, veterans, and supplemental security income recipients. In each case what resulted was very little.

According to Brian Riedl, “no new income is created because no one is
required to work, save, or invest more to receive a rebate.”
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Riedl recalls that to boost the recessed economy in 2001, Washington borrowed billions of dollars from the capital markets. What happened? People bought more, but private domestic investment dropped more than 22 percent and the economy remained stagnant into the following year.

The economy’s growth does take off, says Riedl, when the government spends less and not more.

Keynesian notions about government spending gain credence during challenging economic times for the very human reason that people are comforted by the idea of government taking swift action and coming to the rescue. In fact, the money doesn’t really get spent that quickly. By the time it leaks into the economy, a recovery is usually already occurring. By May 2009, for example, the Obama administration had spent only $31 billion of that “emergency” $787 billion stimulus package that was rushed through Congress soon after he took office.

E
xperts such as Martin Feldstein and
Forbes
columnists and economists Brian Wesbury and Robert Stein worry that the Obama administration’s spending binge will lead to a severe inflation. They fear that with central banks around the world pumping the equivalent of hundreds of billions of dollars into their nations’ economies, we may experience a
hyperinflation similar to what unfolded in Argentina between 1975 and 1991. Overexpansion of the money supply to pay for spending by a succession of Argentine administrations caused prices eventually to soar at a rate of about 3,000 percent a year. Amid the chaos, Argentina’s currency lost just about all its value. People shifted to barter, trading homemade wares, new and used clothes, and jewelry. Inflation was finally halted in 1992. Argentina pegged its currency to the U.S. dollar. But in 2001 the dollar-peso link was severed and another round of chaos followed.

Feldstein’s concerns have particular resonance because he used to head the National Bureau of Economic Research, the nonprofit organization whose data marking the beginnings and ends of business cycles is considered definitive. The highly regarded economist believes that inflation is likely to hit “once we start to recover.”
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With credit tight, money sits in the banks. But Feldstein has voiced the fears of many that once lending resumes and money flows again, prices will skyrocket.

However, economist and
New York Times
columnist Paul Krugman fears the opposite scenario—deflation: “Falling wages are a symptom of a sick economy. And they’re a symptom that can make the economy even sicker.”
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University of Munich economics professor Hans-Werner Sinn believes this deflationary death spiral could mean a future less like that of Argentina and more like that of Japan, whose economy has been crippled since the early 1990s. He explains,