Monday, January 26, 2009

Creating wealth by magic!

Government is the great fiction, through which everybody endeavors to live at the expense of everybody else. -Frederic Bastiat, French Economist (1801-1850)

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The stimulus bill currently steaming through Congress looks like a legislative freight train, but given last week's analysis by the Congressional Budget Office (CBO), it is more accurate to think of it as a time machine. That may be the only way to explain how spending on public works in 2011 and beyond will help the economy today, says the Wall Street Journal.

According to CBO estimates:

A mere $26 billion of the House stimulus bill's $355 billion in new spending would actually be spent in the current fiscal year.

And just $110 billion would be spent by the end of 2010.

This is highly embarrassing given that Congress's justification for passing this bill so urgently is to help the economy right now, if not sooner, says the Journal. Even worse, it seeks to act like a time machine in the sense that it's based on an old, and largely discredited, economic theory: As Harvard economist Robert Barro has pointed out, the "stimulus" claim is based on something called the Keynesian "multiplier," which is that each $1 of spending the government "injects" into the economy yields 1.5 times that in greater output.

There's little evidence to support this theory, says the Journal, because it assumes that the government can create wealth out of thin air; if that were true, it should spend $10 trillion and we'd all live in paradise, says the Journal.

The problem is that the money for this spending boom has to come from somewhere, which means it is removed from the private sector as higher taxes or borrowing. Barro wrote about this way back in 1974 in his classic article, "Are Government Bonds Net Wealth?":

For every $1 the government "injects," it must take $1 away from someone else -- either in taxes or by issuing a bond.

In either case this leaves $1 less available for private investment or consumption.

The government spending will be a net stimulus only if its $1 goes to more productive purposes than those to which private investors would have put that same $1.

There are some ways we may want the government to spend money -- on national defense, say -- but that doesn't mean it's a stimulus, says the Journal.

Source: Editorial, "The Stimulus Time Machine: That $355 billion in spending isn't about the economy," Wall Street Journal, January 26, 2009.

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