There's a Hole in Our Bucket
As a result of the Great Depression, a lot of very bright economists tried to figure out how to keep that nightmare from ever happening again. They came up with several solutions that seemed to work, and actually did through most of the last seventy years. One of those solutions was goosing the money supply whenever the economy seemed to be going into recession, causing interest rates to fall and making adding debt more affordable. A few posts ago, I pointed out why that strategy isn't working as well this time around. Another strategy is fiscal stimulus--running larger than normal deficits during a recession. That's not working as well as it used to anymore either, and the reasons are easy to understand.
The theory behind fiscal stimulus is that if the government spends money, that money creates economic activity far beyond just the money spent. Let's say that the federal government adds additional highway projects. Construction firms hire people to do the projects. Those people take their checks and spend the money on groceries, DVDs, furniture, whatever. That supports the people who make the products they buy and people working at the stores they buy from . Those people, in turn buy stuff too, and the stimulus multiplies itself across the economy. The increased activity actually pays back some portion (though not all) of the money the government spent because the increased earnings means increased tax revenue. Sounds great, doesn't it? Almost too good to be true, right?
It actually has worked that way most of the time for the last seventy years. The stimulus can be either increased spending or a tax cut. Tax cuts leave more money in paychecks, and thus allow more spending by the taxpayer. Economists argue over whether tax cuts or spending increases goose the economy more, but there is a broad consensus among most of them that both tax cuts and increased spending does increase economic activity and at least partly pay for themselves.
We have a tried and true solution, apparently. It has been used by both Republicans and Democrats over the last seventy years. When the 2008 recession came along, first Bush and then Obama hit the accelerator on fiscal stimulus. Obama asked for and got fiscal stimulus that dwarfed anything that had come down the pike before--both increased spending and lower payroll taxes, and predicted that it would quickly bring unemployment rates down to the levels we had previously considered normal. The economy stopped falling as the stimulus worked its way through the system and even grew a little. The total number of people employed in the US dropped by over 8.6 million people from the peak in January 2008 to the trough in February 2010. We got somewhere around half that number of jobs back over the next two and a half years--growth, but extremely anemic growth compared to almost all postwar recoveries, far below the levels predicted based on the size of the stimulus and arguably slowing in the last half of 2012. The quality of the added jobs is also subpar compared to previous recoveries, often temporary and/or without benefits.
Why did the economy respond so sluggishly? Part of the problem is that the structure of the economy has changed. Remember how the affect of stimulus went through the economy? When the highway construction workers went out and spent their money, they helped create US manufacturing jobs. Now a substantial part of their spending creates jobs in China or Malaysia, because that's where manufacturing of consumer goods is mostly done. Once the money goes to Chinese or Malaysian workers, it can no longer multiply throught the US economy. The retail worker who used to earn a meager but not unlivable wage based on that spending? They're replaced by minimum wage people at big box stores. Much of the money that used to go to them now goes out of the community and ends up enriching the already wealthy, who spend far smaller percentages of their income. The current economy acts like a vacuum cleaner, sucking money out of the middle class and toward large companies at the one end and toward off-shore workers at the other.
There is a hole in our economic bucket and until it's patched fiscal stimulus will have only small and temporary affects, with the additional money going out of the economy too fast for it to create a sustained recovery. The question all of us from every political party and every political ideology needs to answer is how do we patch the holes in the economy so we can get back to growth with solid middle-class jobs again?
The theory behind fiscal stimulus is that if the government spends money, that money creates economic activity far beyond just the money spent. Let's say that the federal government adds additional highway projects. Construction firms hire people to do the projects. Those people take their checks and spend the money on groceries, DVDs, furniture, whatever. That supports the people who make the products they buy and people working at the stores they buy from . Those people, in turn buy stuff too, and the stimulus multiplies itself across the economy. The increased activity actually pays back some portion (though not all) of the money the government spent because the increased earnings means increased tax revenue. Sounds great, doesn't it? Almost too good to be true, right?
It actually has worked that way most of the time for the last seventy years. The stimulus can be either increased spending or a tax cut. Tax cuts leave more money in paychecks, and thus allow more spending by the taxpayer. Economists argue over whether tax cuts or spending increases goose the economy more, but there is a broad consensus among most of them that both tax cuts and increased spending does increase economic activity and at least partly pay for themselves.
We have a tried and true solution, apparently. It has been used by both Republicans and Democrats over the last seventy years. When the 2008 recession came along, first Bush and then Obama hit the accelerator on fiscal stimulus. Obama asked for and got fiscal stimulus that dwarfed anything that had come down the pike before--both increased spending and lower payroll taxes, and predicted that it would quickly bring unemployment rates down to the levels we had previously considered normal. The economy stopped falling as the stimulus worked its way through the system and even grew a little. The total number of people employed in the US dropped by over 8.6 million people from the peak in January 2008 to the trough in February 2010. We got somewhere around half that number of jobs back over the next two and a half years--growth, but extremely anemic growth compared to almost all postwar recoveries, far below the levels predicted based on the size of the stimulus and arguably slowing in the last half of 2012. The quality of the added jobs is also subpar compared to previous recoveries, often temporary and/or without benefits.
Why did the economy respond so sluggishly? Part of the problem is that the structure of the economy has changed. Remember how the affect of stimulus went through the economy? When the highway construction workers went out and spent their money, they helped create US manufacturing jobs. Now a substantial part of their spending creates jobs in China or Malaysia, because that's where manufacturing of consumer goods is mostly done. Once the money goes to Chinese or Malaysian workers, it can no longer multiply throught the US economy. The retail worker who used to earn a meager but not unlivable wage based on that spending? They're replaced by minimum wage people at big box stores. Much of the money that used to go to them now goes out of the community and ends up enriching the already wealthy, who spend far smaller percentages of their income. The current economy acts like a vacuum cleaner, sucking money out of the middle class and toward large companies at the one end and toward off-shore workers at the other.
There is a hole in our economic bucket and until it's patched fiscal stimulus will have only small and temporary affects, with the additional money going out of the economy too fast for it to create a sustained recovery. The question all of us from every political party and every political ideology needs to answer is how do we patch the holes in the economy so we can get back to growth with solid middle-class jobs again?