Unpackaging the Stimulus

Talk of a new Great Depression is a bad case of inflationary linguistic hyperbole

“Calamitous events require calamitous actions”. No, that’s not it. “Criminal events require criminal actions”. Still doesn’t sound right. “Extraordinary events require extraordinary actions”. That’s more like it.

This is Gordon Brown’s favourite justification for his fiscal stimulus package. He repeated it during his speech to the CBI on the day before the pre-budget report. I wonder if the assembled businessmen paused to note that it is ludicrous. Even if true – and Mr Brown provided no evidence that it is – this homily cannot guide policy. For it justifies any extraordinary action at all: prancing around chanting “let there be wealth”, shooting every banker in London or, Brown’s preference, flooding society with borrowed money.

The stimulus package is indeed an extraordinary action. It will impose massive debts on taxpayers, prevent prices from signalling the relative scarcity of resources and change the structure of the economy by increasing the size of the public sector and diminishing the flexibility of the finance industry. That is why it requires a better justification than Mr Brown’s nonsense rhyme.

Specifically, it requires a cost:benefit justification. Properly to defend his stimulus package, Mr Brown needs to show us that its benefits from ameliorating the recession will exceed its costs. I doubt any such analysis has been conducted, not only because, if it had been, and if it supported the stimulus package, we would surely be hearing all about it, but also for a more fundamental reason.

If you consider only the costs and benefits to governing politicians, a stimulus package is always a winner. It satisfies the demand that “something must be done” and, more importantly, it delivers benefits today and costs tomorrow. With an election approaching, as one always is, it is not the relative size of costs and benefits that matter to the government, but their temporal order and their “visibility”. For them, if not for us, decades of subdued economic activity would be a price worth paying to avoid an immediate shock.

If you think I am being unduly cynical, remember that Mr Brown agrees with me about politicians’ incentives. In 1997, he accepted what was by then international policy orthodoxy by making the Bank of England independent to set interest rates. The rationale for central bank independence is that politicians cannot be trusted to set interest rates in the nation’s interests rather than their own. They will too often give in to the temptation to create a pre-election boom by setting interest rates lower than they should be. If politicians succumb to this temptation in monetary policy, why should we imagine they are
immune to it in fiscal policy?

This self-interest hypothesis helps to explain the absurdity of the pro-stimulation rhetoric. Where we should get a serious attempt at weighing costs and benefits, we get outrageous exaggeration instead.

For example, Barack Obama has promised to do “whatever it takes” to avoid a deep recession. This is apparently the kind of thing people like to hear, but it is preposterous. Doing whatever it takes – in other words, bearing any cost – to avoid a deep recession would make sense only if nothing could be worse.

If an asteroid were on course to obliterate the Earth and all its inhabitants, it would be worth any cost to prevent it. But, short of such a cosmic calamity, nothing is worth any cost to avoid. Perhaps this is why, in an article in the Spectator recommending stimulation, Nancy Dell’Olio went cosmic, claiming that we are being “sucked into the black-hole of a super recession”. Few stimulators are as comfortable with cosmic exaggeration as Mr Obama and Ms Dell’Olio, an ex-girlfriend of the former England football coach Sven-Goran Eriksson. Most prefer historical exaggeration, relentlessly invoking the Great Depression of the 1930s. Things could get that bad! We need a new New Deal!

A little perspective is required. During the Great Depression, the gross domestic product (GDP) of the US fell by almost one-third and unemployment reached 25 per cent. In the past six months, US GDP has contracted by less than 1 per cent and unemployment has risen to 6.5 per cent. Perhaps, without stimulation, unemployment would more than triple and the current rate of economic contraction would continue, unabated for 17 years, but it seems unlikely. I have seen no analysis that suggests anything like it.

And, even if this very unlikely reduction in GDP did occur, we would still not experience a repeat of the Great Depression. For we are starting from a position of greater wealth. During the Great Depression, US per capita GDP fell from about $7,800 to about $5,500 (in 2008 dollars). A 30 per cent decline today would result in per capita US GDP of $32,000 – which is higher than Italy’s is now.

To claim that we are staring down the barrel of another Great Depression is simple nonsense. Yet it is not as absurd as another ploy popular with advocates of stimulation: namely, counting its costs among its benefits.

Mr Brown plans to fund his stimulus package (in fractional part) by increasing the tax rate on income over £150,000 from 40 per cent to 45 per cent from 2011. On average, those affected will pay an extra £3,150 a year.

In her Guardian column, Polly Toynbee celebrated this as a step in the direction of “social justice”. By her reckoning, Mr Brown’s stimulus package has two benefits: it will ameliorate the recession and it increases the amount of tax paid by the rich. She counts the average loss of £3,150 by those in the top one per cent of income-earners among the policy’s benefits. Toynbee insists that the rich deserve to lose this money and perhaps she is right. But a deserved loss is still a loss and thus a cost of the policy. She is muddling moralising and accounting.

Few are as keen on taxes as Toynbee. But almost everyone is keen on employment, and this may explain the near-universal tendency to count job creation among the benefits of the stimulus package. To see why it is not, suppose Mr Obama pursued his Green New Deal idea and spent billions of dollars on building wind farms. The benefit of this would be the wind farms that are built, not the employment of those who build them. The employment is part of the cost. If those same wind farms could be produced with less labour, America would be better off. The labour saved could be deployed elsewhere to produce other valuable things.

New Deal-style infrastructure projects may be a good idea, as may be taxing the rich after 2011 to fund consumption today. But you cannot properly defend such policies by pretending that their costs are actually benefits, nor by massively exaggerating the dangers we face and, hence, the value of a stimulus package that avoids them. The economic decisions being taken by our leaders are extremely important, yet the rhetoric surrounding them is fatuous. Though not surprising, it is disgraceful. For, as Mr Brown might put it, serious actions require serious justifications.

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