I recently laid out the fundamental problem with the US economy:Massive consumer debts and high unemployment are crippling consumer spending, which accounts for about 70% of our economy.
I noted that, to get the economy healthy again, consumers have to get back to work and reduce their debts. This latter process has begun, but it will take significantly more time, probably another decade.
No one can wave a magic wand and make consumer debt go away. (If they could have, they would have).
What someone can do is wave a magic wand and create jobs–jobs that benefit the whole country and put spending money back in consumer’s pockets.
Who can wave that magic wand?
Instead of cutting spending and firing people, the way it has been for the last few years, the government can do the opposite: Commit to spending, say, an extra $2-$3 trillion over the next decade to rebuild our country’s infrastructure–and create work and awesome infrastructure for millions of Americans in the process.
Yes, the government could also commit to hiring more teachers, firefighters, policemen, and other folks who generally improve life for all Americans. But hiring those folks is much more controversial. So the government should start with a massive infrastructure spending program.
But wait. Can we afford to spend $2-$3 trillion on infrastructure? We already have $15 trillion of debt, and we’re accumulating more debt at a rate of more than $1 trillion per year!
The answer is…. yes, we can afford it. As long as we commit to fixing our social-insurance programs (Social Security, Medicare, Medicaid) over the next decade. Those programs are what are slowly bankrupting this country, not infrastructure spending. And in the meantime, our infrastructure is collapsing.
Don’t think we should initiate a massive infrastructure spending program? Believe folks who tell you that “government spending doesn’t work?” Think the 2009 stimulus proves that government spending doesn’t work?
Then read on…
YES, GOVERNMENT SPENDING DOES WORK–SOME GOVERNMENT SPENDING
The economy is basically composed of three big spending engines —consumers, corporations (investment), and governments. So when the first two weaken, as they have in recent years, the third can help offset this weakness.
Specifically, the government can increase its spending to offset the lost consumer and business spending.
When governments spend money well, moreover—such as on infrastructure projects that benefit all citizens—the impact of this spending lasts far beyond the years in which the money is spent. Roads, bridges, schools, airports, national broadband networks, and other investments can improve the country for decades. When the government spends money badly, meanwhile–on bailouts and handouts and by perpetuating unsustainable promises of entitlement programs–the money is just wasted.
Ever since the 2009 stimulus “failed to fix the economy,” the consensus in the US has been that government stimulus doesn’t work. There’s actually a lot of evidence to suggest that it did work, or at least helped improve the situation (check out these charts). But the theory that government spending “doesn’t work” is pervasive.
In support of this theory, everyone first points to Japan, where the government has been frantically “stimulating” the economy for two decades now. Then they point to the Great Depression, with its massive public-works programs.
But other evidence suggests that the impact of government stimulus, specifically infrastructure stimulus, is being badly misunderstood.
Photo: Richard Koo
The work of economist Richard Koo, for example, suggests that Japan’s stimulus has been vastly more successful than is commonly believed.Far from not working, Koo argues, Japan’s government stimulus has kept Japan’s economy alive for the past 20 years. Without the stimulus, Koo says, Japan’s economy would not have crawled along for the last two decades—it would have collapsed.
When the same logic is applied to the US stimulus of 2009-2010, the conclusion is that the stimulus “failed to fix” the US economy, but that it kept the recession from being much worse.
In addition to Japan, one of the most often-repeated examples cited by those who say stimulus doesn’t work is the US experience in the Great Depression. To see that stimulus doesn’t work, they say, all you need to do is look at the huge public-works programs of the 1930s, which failed to pull the US permanently out of the Depression. What finally got the US out of the Depression, these folks continue, was World War 2.
But what was World War 2 if not a gigantic government stimulus?That’s exactly what World War 2 was. It put the US government deeply in debt, vastly deeper in debt than we are today. But it got our production engine humming again. And it set the stage for decades of impressive growth, during which we eventually worked off the World War 2 debt.
So there’s a lot of evidence to suggest that the current consensus that stimulus “doesn’t work” is flat-out wrong.
In fact, the evidence suggests, stimulus can keep the economy from collapsing while the private sector heals itself.
And this, in turn, suggests that ruling out future stimulus in the form of infrastructure investment as a way to help the economy is a major mistake, especially with US infrastructure in such lousy shape and so many US workers idled by the construction industry slowdown.
To learn more about how government stimulus helps economies get through depressions, flip through some of Richard Koo’s excellent slides below. They focus on Japan, the Depression, and recent US and Europe experiences…
For starters, Richard Koo shows what he believes would have happened to Japan if the government had NOT embarked on a massive stimulus plan. That's the dotted red line below. The purple line on the bottom, meanwhile, shows how far asset prices have collapsed. The top two lines show actual GDP--real and nominal. Much of the GDP came directly from the government.
And when the private sector is tapped out, tax revenue doesn't increase (blue line below). If Japan had cut government spending to keep the deficit in line with taxes, its own spending would have decreased (dotted red line). Instead, it stomped on the gas (purple line). Imagine what Japan's economy would have looked like if it hadn't.
Another way to see the impact of government stimulus in Japan is to look at the money supply: Government borrowings have sustained the economy while private borrowings shrank. Reducing interest rates wasn't enough: The government actually had to SPEND.
Japan's occasional attempts to balance the budget along the way, meanwhile, clobbered the economy and, importantly, tax revenue (white bars below). As the grey bars below show, these measures also did not meaningfully reduce the budget deficit.
The Great Depression in the US, Koo argues, was similar to Japan's current situation. Then, as now, the fear was that, if the budget wasn't brought into balance, interest rates would skyrocket. But Koo observes that, during the Depression, US interest rates stayed low for decades. So we may be able to borrow more than we think we can.
In another US Depression slide, Koo shows how government spending sustained the economy (and money supply) during the Depression. It didn't fix it, but it helped.
So that brings us to the US (and Europe) today. Koo argues that the US is experiencing the same thing Japan has experienced for two decades: A private-sector deleveraging. Lehman was a shock, Koo argues, but we'd have gotten here anyway.
The US responded to the Great Recession by slashing interest rates to zero. But that didn't help. Because consumers are deleveraging, and no one wants to borrow money. So loans (green) and consumer spending (yellow) continue to decline.
Koo also observes that democracies like the US and Europe have a much tougher time enacting the necessary fiscal stimulus than authoritarian governments. Especially in crappy economies with big debts (ours), the arguments against increasing government spending just sound too compelling.
Business Insider Emails & Alerts
Site highlights each day to your inbox.