We should resist the temptation to see the forthcoming "economic stimulus" package as a panacea. It won't be. At best, it would represent traditional "pump priming." This familiar metaphor is worth pondering. To get the pump started, you add water; then the pump operates independently. Similarly, the stimulus will succeed only if the economy resumes spontaneous expansion and job creation.
The incoming Obama administration has understandably focused on the immediate task of designing the stimulus program. It has said less about how it would encourage self-sustaining economic growth. But that, in the end, is the crucial issue. Ever-expanding government budget deficits — reflecting spending increases and tax cuts — would ultimately be ineffective and self-defeating.
The stimulus qualifies as a necessary evil, a parachute against an economic free fall. Conventionally, the economy is sliced into four sectors: consumer spending; business and housing investment; net exports; and government spending. The first three sectors are weakening. Consumer confidence is at a record low, according to a Conference Board survey conducted since 1967. Only 6 percent of Americans think jobs are plentiful; 41 percent think there will be fewer jobs in six months. Housing construction has collapsed; businesses are fearful of making new investments. Exports suffer from faltering foreign economies.
If government doesn't prod the economy, what will? The danger is that pessimism and shrinking spending would feed on each other, pushing output down and unemployment up. By propping up production, employment and confidence, a stimulus package aims to buy time. Even so, joblessness would rise. IHS Global Insight predicts that it will peak at 9.2 percent in early 2010. But a free fall would be averted, and as overborrowed Americans repaid their debts, they would resume higher spending. Bloated housing inventories would decline; home construction would revive. Business investment would follow.
That's the theory.
By all reports, the stimulus will be massive. Stanley Collender, a respected budget expert, thinks the 2009 deficit could exceed $1.3 trillion, about 9 percent of the economy (gross domestic product). In dollars, that would triple the 2008 deficit of $455 billion. As a share of GDP, it would dwarf Ronald Reagan's post-World War II record of 6 percent in 1983. Gasp.
(For numbers junkies, here's Collender's math. He starts with the Congressional Budget Office's latest 2009 estimate, $438 billion. He then adds $500 billion in stimulus, assuming that some of the stimulus will be spent in 2010. He also adds $100 billion unbudgeted so far for Iraq and Afghanistan, $80 billion for relief from the alternative minimum tax, and $250 billion for the Troubled Asset Relief Program. Note: The TARP figure involves highly technical accounting rules.)
Under some circumstances, the stimulus could backfire. One possible pitfall is that foreign and domestic investors in U.S. Treasury bonds might balk at buying so many more securities. To convince them, interest rates might have to rise, which might perversely worsen the crisis. There might even be a panicky flight from the dollar. So far, the opposite has happened. Scared investors have crowded into "safe" Treasuries and driven their interest rates to astonishing lows. Still, psychology has governed this unpredictable crisis; a sudden shift in sentiment isn't inconceivable.
Even if this unpleasant surprise and others don't materialize, the stimulus remains a stopgap. The present crisis represents a fundamental break in the recent pattern of American economic growth. For the past quarter-century, the economy has advanced on an ever-rising tide of personal borrowing that supported expanding purchases of consumer goods — contributing to U.S. trade deficits — and a housing boom. But lending became reckless, and many households overborrowed. In its simplest terms, the "stimulus" substitutes the federal government's superior credit for damaged private credit.
But this cannot continue indefinitely. Rapid increases in the federal debt — much faster than in recent years — would threaten a further loss of confidence that might prolong today's financial crisis or, someday, trigger a new one. A growing federal debt burden would also compound the problem of paying the staggering retirement costs of aging baby boomers. So: Neither rising household nor government debt provides a plausible foundation for future economic growth.
What the United States needs is export-led growth. The rub is that many other countries want that, too. Just as large U.S. trade deficits signified American overspending, large trade surpluses in China, Japan and other Asian countries signified their oversaving. In China, consumption spending is 35 percent of GDP, notes economist Nicholas Lardy of the Peterson Institute. That's half the American level.
The future of the U.S. economy depends on finding new sources of productive demand. That is partly a domestic exercise, but it also requires that other societies reduce their oversaving and reliance on exports. This is a tall order. Our fate is not entirely in our hands — or Barack Obama's.
