The Fallacy of “Fiscal Stimulus”

Stimulus during the Great Depression delivered an unemployment rate of 25 percent

The trouble with conventional wisdom is that it is not always wise. The recent calls for government bailouts and an “economic stimulus” package-by which advocates mean pouring hundreds of billions, or even trillions, of dollars into failing industries and into public works projects-is an excellent case in point.

Congress has already authorized enormous bailouts for banks, insurance companies, mortgage companies, the ‘Big Three’ U.S. automakers, and so on. These actions have enriched those in failing businesses at the expense of more productive businesses and everyone who pays taxes.

Now state and local governments are asking the federal government for a bailout of their own.

Last month, the National Governors Association estimated that the states have $136 billion in infrastructure projects ready to go. Gov. Arnold Schwarzenegger’s office has said that California has $28 billion in projects the federal government could fund during President Barack Obama’s first 120 days in office (ignoring the fact that the state’s voters approved $42 billion in infrastructure bonds just two years ago).

Not to be outdone, the United States Conference of Mayors recently presented its own wish list of 11,391 “shovel ready” pork-er, “infrastructure”-projects totaling more than $73 billion. The list of projects includes such critical infrastructure needs as sports complexes, museums, tennis courts, bike paths, and median landscaping.

But when Uncle Sam has racked up so much debt that the fiscal house of cards inevitably collapses, who will bail out the American taxpayer? The truth is that the idea that government spending can somehow cure economic ills does not work. It didn’t work during Japan’s “Lost Decade” of the 1990s, it didn’t work during the Great Depression, and it will not work today.

In the 1990s, after a real estate and stock market bubble burst in Japan, the Japanese government passed 10 fiscal stimulus packages in an attempt to turn the economy around. The programs focused largely on public works and cost more than 100 trillion yen ($1.1 trillion in today’s dollars). Those plans didn’t succeed in reviving the economy, but they did saddle the nation with a mountain of debt that helped postpone any recovery for years.

Even the mother of all stimulus plans, President Franklin Delano Roosevelt’s New Deal, which actually had its roots in the Hoover administration, did not work to “stimulate” the economy. Despite all that spending and all those make-work programs, unemployment remained extremely high. In 1929, the unemployment rate stood at a little over 3 percent. By 1933, it had risen to 25 percent. Yet, even after years of New Deal programs, unemployment remained around 15 percent or higher through 1940. It was not until World War II that unemployment dropped back down to the low single digits.

But if all this borrowing and spending will really bring the recession to an end, why stop there? Why not borrow $10 trillion or $1 quadrillion to really get the economy purring again? Because it doesn’t work. Because government can print money, but it cannot create wealth. It can only give what it has already taken (or will take in the future)-after skimming a bit off the top to keep the bureaucracy going.

Prior to 1929, it was generally acknowledged that the federal government should not try to manipulate the economy to mitigate the effects of economic downturns. Not coincidentally, even the more severe recessions/depressions were short-lived, typically resolving themselves within a year or two. Today, allowing the economy to liquidate the malinvestments that were made when the Federal Reserve drove interest rates to artificially low levels would surely cause some short-term pain, but doing so is necessary if the economy is to get on the right track. Perpetuating poor economic decisions through “stimulus” programs will only prolong the recession and make the inevitable correction even more painful in the end.

As difficult economic conditions drag on and more and more people clamor to bail out various industries, or request hundreds of billions of taxpayer dollars to “stimulate” the economy, let us remember where all that money is coming from-us! Money taken for the purpose of “saving” industries or “protecting” jobs is money diverted to less productive ends. Ultimately, bailouts and economic stimulus bills will only result in less wealth production and a lower standard of living.