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 Richmans' Trade and Taxes Blog

The Costly Obama Stimulus Is Not Working
Raymond Richman, 2/25/2010

A distinguished economist, Prof. Robert J. Barro, Harvard University, in an op-ed in the Wall St. Journal, 2-23-2010, calculated the likely contribution of the Obama stimulus package to the Gross Domestic Product (GDP) over the five year period beginning February, 2009, a year ago, and estimated the effect it would have on the GDP. He estimated an increase in the GDP of $120 billion in 2009, $180 billion in 2010, $60 billion in 2011, minus $330 billion in 2012, and minus $330 billion in 2013. Over the five year period, the sum of the effect on Consumption, Private Investment, and Net Exports is minus $900 billion. He concludes,

Thus, viewed over five years, the fiscal stimulus package is a way to get an extra $600 billion of public spending at the cost of $900 billion in private expenditure. This is a bad deal. The fiscal stimulus package of 2009 was a mistake. It follows that an additional stimulus package in 2010 would be another mistake.

As we have stated in a previous blog, we believe that there is no Keynesian multiplier, that the economic stimulus package would increase GDP by an amount  equal to the increased government expenditure and that when the stimulus expenditures ended, the increase would end with no further stimulus to GDP. Prof. Barro calculated and employed a 1.4 multiplier in the first year of the stimulus package and 1.6 in the second year. When the stimulus is deficit-financed, he estimates a negative 1.1 multiplier. The 2009 data appear to confirm his calculations.  

But we believe they are also consistent with our theory, which we expressed in an earlier blog, that in a prolonged recession the multiplier is likely to be 1.0 because of the non-existence of any multiplier effects.. Only when residents experience an increase in income they believe to be “permanent” will they increase their consumption. We based that conclusion on Milton Friedman’s permanent income hypothesis, namely, that changes in consumer expenditures occur only when the consumer experiences what he believes to be a “permanent” change in expected lifetime income. Almost none of the income generated by Obama’s economic stimulus package could be considered other than temporary. As a result, increased expenditures generated by the package would increase GDP only by the amount of the increased government expenditure and only so long as the expenditure continues.

Be that as it may, we are in agreement with his conclusion that the cost of the stimulus package increases GDP by the amount of the increased government expenditure on goods and services directly or indirectly. The change in GDP over the five-year period in our view would be 250, 500, 125, 0, and 0 if the total amount of the package were spent on goods and services. Personal Consumption Expenditures, Private investment in factories, equipment, research and development, and Net Exports, we assume, would not be affected by the stimulus and they would thus not contribute to increased GDP.

As for stimulating net exports, we have consistently argued that the trade deficits need to be eliminated. We believe that we need to recapture some of the industries we lost as a result of Chinese and Japanese mercantilist policies.which go unmentioned by Prof. Barro, are likely to increase because there is no automatic correcting mechanism to bring trade into balance. China, Japan, and other countries peg their currencies to the dollar. As a result, our exports remain expensive and their exports remain cheap.  The trade surplus countries, especially, Japan and China , do everything in their power to prevent their exchange rates from increasing relative to the the dollar. As for Germany, there is evidence that auto exporters absorbed the effects of the nearly 50% decrease in the value of the dollar relative to the Euro.

We have it in our power under the rules of the World Trade Organization to take unilateral action, such as tariffs and import restrictions to bring trade into balance. Indeed, tariffs imposed against China, Japan, and Germany would yield a huge amount of tariff revenues while trade becomes reasonably balanced. We believe that a reasonable balance of trade would make producing industrial goods in America profitable once again, be a huge stimulus to industrial investment, and begin the process of reindustrializing America.

Other policies that we have recommended to grow the economy include 1. eliminating the barriers to oil and gas drilling, 2.eliminating the bias against nuclear energy, 3.running all trucks and buses on natural gas or electricity which is in abundant supply, 4.substituting electricity for fossil fuels, and 5.abolition of the corporate income tax and substituting a progressive tax on consumption. These are easily implemented, constitute a great economic stimulus package and will put millions to work quickly with real multiplier effects! 

Our recommendation for abolition of the corporate income is the result of Prof. Harberger’s findings that the corporate income tax is passed forward to consumers in the U.S. market but cannot be passed forward in international markets. It thus makes American corporations less competitive vis-s-vis foreign producers and encourages moving factories abroad.

The way to stimulate the economy is to make private direct investment in U.S. industry profitable again. Throwing money at problems as a stimulus to consumption has no permanent effects. The changes we recommend require few if any government expenditures, will actually increase government revenues, and get at one of the causes of the recession – the closing of American factories and the loss of good industrial jobs.

Comment by Zbigniew Mazurak, 2/27/2010:

"3.running all trucks and buses on natural gas or electricity which is in abundant supply, 4.substituting electricity for fossil fuels, and 5.abolition of the corporate income tax and substituting a progressive tax on consumption. These are easily implemented, constitute a great economic stimulus package and will put millions to work quickly with real multiplier effects!"

With all due respect, Dr Richman, I'd say that your recommendations #3-#5 wouldn't be easy to implement.

Ad3) There are actually very few recharging stations and very few electric trucks and electric buses (or hybrids) in the US. There is a respectable number of LPG-propelled trucks and buses, and LPG is available at most gasoline stations, but the problem with it is that the gasoline engines of trucks and buses would've to be replaced (at a significant fiscal cost) with LPG-engines; very few truckers or bus owners would pay for those LPG engines. Plus, LPG is a finite resource, just like oil. Plus, LPG-propelled vehicles would mean that (unless the ANWR-OCS-Rockies ban is abolished by the Congress) America would be dependent on Russia and Iran for natural gas. I don't believe the US should subsidize Putinist Russia nor the Iranian nuclear program.

Ad4) Like I wrote above, "There are actually very few recharging stations and very few electric trucks and electric buses (or hybrids) in the US." There are also very few electric cars in the US.

Ad5) I like the Fair Tax. It's a good policy, and GOP presidential candidates should endorse it. But the FT is facing 2 obstacles:

Firstly, the Congress and the tax lobby are refusing to allow a simple tax code and refusing to stop manipulating the tax code. They want a complex tax code to maintain the tax advisory industry.

Secondly, the Congress would need to approve a constitutional amendment to repeal the 16th Amendment. This is necessary to ensure that the Fair Tax will be the sole federal tax (other than fuel taxes), or else the Congress will use it as an additional source together with, not instead of, other federal taxes. The chance that the Congress will approve an amendment to repeal the 16th Amendment is low.

I'm not saying that the policies you've proposed shouldn't be pursued. The Congress should adopt them, but it would be difficult to implement them.

Response to this comment by Raymond L. Richman, 2/27/2010:
  Thank you for your wise observations. You are probably right that my recommendations #3 and 4 wouldn´t be easy to implement. But that is a question of political will and some of my recommendations would not require legislative action. For buses and trucks, it would not be necessary for every service station to be equipped. Municipal bus companies could own their own facilities. In many cities, the vehicles of the local gas companies already run opn natural gas. Restrictions that prevent home-owners and farmers from using natural gas from wells on their properties but there are already a number who use kits. As for the supply of gas, Canada and Alaska are in the process of planning a pipeline which will deliver gas to Southwestern Canada; gas wells are tapping into shale deposits in Pennsylvania. They are using horizontal drilling techniques that fracture the shale thousands of feet. Estimates of the reserves of natural gas suggest a huge.supply available for the drilling. If the obstacles are removed millions of vehicles could be using natural gas and petroleum based gas within a decade. We like the fair tax, too. I would prefer a progressive consumption tax in the form of a simplified income tax with savings exempt from the tax.