No Time to Waste

The debate over stimulus packages in the United States, Britain, Germany and other countries of the European Union has veered off course.

The issue is not whether permanent tax cuts or infrastructure investments are desirable policies for the long-run. Those issues must be decided independently of where any economy is in the business cycle.

The question is whether temporary, emergency measures are needed to prevent, or to mitigate, a spiral down into a depression. The measures that ought to be discussed are not programs for the fiscal fitness of economies, but emergency interventions to stem the bleeding.

Looking at the problem properly leads to two quick conclusions. First, tax cuts are not the way to meet the challenge.

“Temporary” cuts in tax rates, as contemplated in the U.K., are hard to reverse. More fundamentally, when businesses and households face great uncertainty, they are likely to put their tax reductions into new savings or debt reduction, hardly what we need to take up the slack in the world economy.

Second, stimulus spending must result in demand for goods and services, spending that can be started up and shut back down relatively quickly.

J.M. Keynes was only half joking when he suggested that meant having one group of workers dig holes and another fill them up. When factories (and construction firms) are idle, workers are unemployed, and nobody dares start an economic venture. Any project that puts people to work, generating income that will be used to buy things, serves a counter-cyclical purpose.

The challenge, of course, is to find spending programs that not only pump up demand quickly but that provide something useful as well.

There is little doubt that the world economy is spiraling downward. Every economic partisan and quack will advocate his or her favorite snake oil, whether it is tax cuts for the rich or programs to build more parking lots.

The guiding principles for the stimulus packages that every advanced country needs are:

• Do something, fast.
• Make sure that every euro or dollar of additional government debt results in a lot of demand for goods and services.
• Do not make long-run commitments to solve this short-run problem.

Finally, another major concern of many commentators should be laid to rest. The sharp rise in national debt that will result from stimulus spending should be no problem in the long-run.

We must build up the national debt when private spending plans are insufficient to keep the economy moving.

Normally, the production plans of businesses more or less mesh with the spending plans of households, businesses, and governments. What gets produced gets sold. Households meet their income and spending plans and governments meet their revenue expectations.

But in a serious recession or depression, households are scared to spend, businesses are scared to produce, government revenues plunge, and the economy spirals downward. In these circumstances, it is not only acceptable for governments to run big deficits, it is vital that they do so. If government demand does not take up the slack in the economy, what will?

The countries that have chronic fiscal problems — Italy and Argentina, for example — are not plagued by the consequences of past countercyclical interventions.

Rather, their problems are a consequence of political weakness and a long-standing unwillingness to tax enough to cover their spending (or to spend no more than they routinely collect in taxes).

The United States offers an example of a country, which — until 1980, at least — had no chronic tendency to entertain fiscal delusions, but which nevertheless accumulated massive debt fighting the Great Depression and then the Second World War.

In 1946, the national debt was 120% of GDP. Over the next 35 years, the debt was reduced to 33% of GDP.

This was accomplished not by heroic austerity, but simply by good budgetary policy, with limited deficits, a few surpluses on the budget and a steadily growing economy. (After 1981, the Reagan-Bush-Bush fantasy of “supply-side economics” has once again raised the debt/GDP ratio, but this will be corrected in the future.)

The world escaped the Great Depression only through a great and tragic war. In the long run, one way or another, we will escape the current economic crisis too.

But in the short run, in the months during which a stimulus package must have its effects, governments must be seen to be active and caring. They must undertake projects that create optimism as well as income, and they must do so now.