Monday, January 05, 2009

Trickle-Over Stimulus

Nobel Prize winning economist Paul Krugman has been arguing that the best way to stimulate the economy is to increase government spending. No amount is too much. Now that word is leaking out that soon-to-be President Obama is planning a tax cut as part of his stimulus, Krugman is against it. To him, it should be direct government spending or nothing. What are the arguments each way?

Krugman points out that tax cuts, rebates, etc. may not directly stimulate the economy. People might do something foolish with the money like save it or pay off some bills. That happened with the stimulus checks that Bush sent out last year. Only 1/4-1/3 was spent so the economy wasn't stimulated all that much.

Krugman argues that a government-investment program makes sure that all of the money is spent and that public spending leaves something of value behind when the stimulus is over.

Before we start writing government checks, there are several things to keep in mind.

First, in defense of tax cuts, I'd like to point out that I might blow the whole thing on a new couch or washing machine. That means that I have something of value when the stimulus is over. On the other hand, there are lots of public projects that I would never, ever use. Look at the Alaska "bridge to nowhere" (yes, I know that it was eventually canceled but it is an example of road projects). Infrastructure spending carries the risk that massive projects will spread out according to political connections rather than the number of people who will benefit.

A lot of the proposed spending is for infrastructure repair. This may be needed but don't kid yourself that repaving a road will have the same stimulus effect as building a new one. Rebuilding a bridge or road can disrupt business until the work is finished. The projects that are "shovel ready" are not the sort that will stir the economy. They are short-term projects. They will keep construction workers from being idle. They might even provide workers some overtime. How will this help the rest of the economy? The big projects, new roads and bridges that would provide long-term stimulus take years to plan and build and even more years before the stimulus effect really sets in. A new highway exit might take a couple of years to plan and build but the economic effects would not show up for an additional decade. In the meantime, the only ones who see any stimulus are the ones who built the exit ramp.

In theory, the construction workers will spend the extra money that they receive rather than paying off debts or saving it. This will cause an economic ripple that should eventually reach everyone. Unless you work for an industry that will receive government contracts for "shovel ready" work, you will never see a penny of the stimulus directly.

Herbert Hoover tried something like this. He maintained that if he helped the biggest banks and other businesses, they would help the smaller ones and the money would eventually tickle down to everyone.

Krugman is pushing a variant of trickle-down. Instead of spreading the stimulus around to the general population he advocates stimulating a small (heavily unionized) portion of the economy in the hope that the effect will carry over to everyone else. Call it Trickle-Over economics.

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