Stimulus spending and common sense
A preponderance of economists and economic commentators support the use of stimulus spending to counter recessions. The IMF supports it; the G20 governments support it, Treasury head Ken Henry supports it, bank economists are often quoted as supporting it and economic columnists in newspapers support it. Support for it is overwhelming. If the degree of support counts then the matter is settled and perhaps to an even greater degree than is the "settled matter" of man-made globing warming.
A few brave conservative souls – Galileo-like – fly the flag for the opposing view. (Within Australia, Steven Kates is prominent among them in Quadrant Online and elsewhere.) They make the case that boosting government expenditure in recessionary times does more harm than good and lessens economic growth. Inevitably, the debate has become politicised and, as with global warming, once that occurs tribal positions are cemented in place and light and reason have a hard job breaking through, whatever the evidence.
The evidence, in any event, is likely to be inconclusive because we can’t run counterfactual experiments with economies. Free market economies generally recover whether economic policies are good or bad. Whenever they recover governments will claim credit for their policies; whenever recovery stalls governments will claim that without their policies things would have been worse. In the end result we are left with conceptual thinking of some kind, rather than with hard evidence, to decide the case.
When the government handed out "free money" late last year and early this year, I spoke to a number of people, casually in the course of going about my daily affairs, about what they thought of it. Responses broke into two categories roughly. Some people’s response went not much further than saying, in one way or another, that the money was welcome. Others while cynical about the exercise still, unsurprisingly, welcomed the money. No-one proffered a view as to whether it was good or bad economic policy. This is understandable; the vast majority of people have no effective means of accessing or participating in economic policy debates. They have neither the knowledge nor the platform. They have to rely on common sense when it comes down to favouring one course of action or another. This set me wondering whether conceptual thinking of the common sense kind might do the job of unlocking this "settled matter", where professional jousting continues to fail.
Common sense has enormous application in the administration of justice, why not in economics? Common sense applies practical judgement based upon generally agreed premises and on logical derivatives of those premises.
In the current case, an apposite premise, which should find general acceptance, is that economic recessions, however triggered, result from a very large number of normally profitable businesses pulling back on their borrowing, investing, producing and employing. They do this because they become uncertain and negative about their ability to continue to sell the products that they produce at prices, and in sufficient quantities, to remain profitable.
Two unexceptional broad guidelines for policymakers fall out of this premise.
- Policymakers should assist in creating an environment which offers all viable businesses a more certain and profitable future.
- In creating this environment, policymakers need to avoid favouring one kind of business over another or propping up businesses which are unviable in normal economic times. Therefore, so far as possible, it follows that policy should be neutral as between different businesses to allow competitive market forces to play out.
At issue is how particular policies fare when measured against these two guidelines by following a logical train of thought.
Easing monetary policy scores highly. Lower interest rates tend to benefit all businesses but offer little in the way of special protection to unviable businesses. Assuming that easing monetary policy brings the whole yield curve down, as it usually does in the first instance in recessionary periods; businesses can lock in long-term borrowing at lower rates.
Lowering business income tax rates scores highly provided there is a measure of certainty that lower taxes are affordable and will remain in place. They benefit all profitable businesses but offer little benefit to unviable businesses because such businesses earn little or no profits on which to pay tax.
Stimulus spending scores poorly. Typically stimulus spending is geographically diffuse but concentrated on small building and construction projects (for example, in Australia, on school buildings, ceiling insulation and local and regional roads). This is because the aim of the spending is to create “shovel ready” jobs (as they were described by President Obama) in as many places as possible, as quickly as possible, and governments have little scope to try to do this other than through building works. Because this spending is one-off and temporary there is no compelling reason to suppose that it will to create confidence in the medium/longer term future among the business community generally. Because it is skewed towards the building and construction sector it is not competitively neural, and may also temporarily prop up unviable businesses within that sector.
When little benefit is offered, size is important. A small amount of stimulus spending doing little good; does little harm. A large amount of spending doing little good; does harm, because it has to be financed on the other side and because it draws resources away from where they can be used more productively.
Common sense conclusion: The massive one-off stimulus packages of the kind implemented in Australia and elsewhere are likely to be counterproductive and are, in any event, inferior to other policies which have a longer term and more widespread impact in improving the business environment.