Oh wow, more people that know the stimulus won't work

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http://www.forbes.com/opinions/forbes/2009/0202/013.html

"With all thy getting get understanding."

Steve Forbes 02.02.09, 12:00 AM ET

Big Bar to Robust Recovery: Bad Ideas

The U.S. is enacting a "stimulus" program of gargantuan peacetime proportions to rejuvenate our recessed economy. We are not alone in this. Japan, China, Europe and numerous other nations are doing the same--not yet as big as our program but based on the idea that governments can rekindle growth.

It's all mostly wasted effort.

Governments are indeed critical to economic growth--but not in the manner we see unfolding here. While times and circumstances change, principles of economic growth do not. The basic ones have stood the test of time:

--The rule of law, especially property rights.

--Money that is stable in value, which the dollar manifestly has not been.

--Low tax rates.

--Ease of starting a new business.

--Minimal barriers to doing business, whether overseas (low or no trade barriers) or domestic (no internal cartels or onerous licensing procedures).

Despite its sheer size, the impact of the new President's fiscal program, after the initial euphoria, will be painfully limited. Instead of a jolt like from downing a six-pack of Red Bull, we'll get the economic equivalent of a tepid cup of decaffeinated tea. In fact, the waste and misuse of much of the money--inevitable in any quick, massive government-managed or -directed program--will negate much of the good in parts of this infrastructure-spending package.

While the economy will start to grow again in a few months--because of extra liquidity now being pumped in by the Fed, lower energy costs and very low inventory levels--the Obama programs could well impede or retard the pace of this nascent expansion. It could be a minor version of the way FDR's incessant experiments in the 1930s--price and wage controls, massive regulation, huge tax increases, forced unionization--severely damaged the U.S.' climb out of the Great Depression.

The blunt truth is that government spending is a poor substitute for private business and consumer investing and spending. Were it otherwise, the Soviet Union would have won the Cold War, and Japan, which had numerous Obamaesque stimulus packages in the 1990s, would have boomed instead of remaining dead in the water in what was a 12-year recession.

Why this belief in government spending? After surveying the wreckage of the Great Depression, British economist John Maynard Keynes posited that markets left to themselves were inherently unstable and that government intervention could prevent debilitating economic slumps.

"In the long run we are all dead," Keynes once famously quipped. Alas, Keynesian dogma never dies.

If entrepreneurs and businesses are not investing and consumers are not spending adequately, the idea goes, then government can come in and fill the void. "Voilà!" The economy will bounce back. In short, government can mobilize idle money via higher taxes and borrowings (Obama's money would all come from borrowing) and put it to work. It might even print some extra money--Keynesian economists still see a little bit of inflation as a positive for economic growth. The economic battery is recharged. Businesses recover their animal spirit, consumers their propensity to spend.

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So why did such an approach fail so miserably in the 1930s? Economists such as Nobel Prize winner Paul Krugman and Federal Reserve Chairman Ben Bernanke would say it was because Washington didn't spend enough.

What about Japan's spending binge in the 1990s that still left its economy stagnant? That's waved away because of Japanese peculiarities, such as the intimate ties between banks and cabals of affiliated Japanese companies, or something like that.

What about western Europe, which has had a massive government presence during the last 30 years but has created only a small fraction of the private-sector jobs that the U.S. has? Spenders just ignore that and prattle on about the wonderful quality of life western Europeans enjoy.

Despite adverse experience, the Keynesian stimulus idea has a viselike hold on policymakers, pundits and academics. It ignores the actual reasons that we experience slowdowns. As Joseph Schumpeter, the 20th century's foremost economist, observed, dynamic growth in the standard of living requires constant innovation--and volatility. One example of innovation leading to volatility is traditional media. Even without the current economic slump, this area would still be undergoing Internet-generated convulsions.

Events can also roil economies, as we experienced after 9/11. But most often, bad government policies bring on the most damaging downturns. The Great Depression was ignited by trade wars, high taxes and bad monetary policies. The great inflation of the 1970s was caused by the Federal Reserve's excessive money printing. The current crisis was brought on by the weak dollar, the reckless extravagances of Fannie Mae and Freddie Mac and regulatory errors, such as mark-to-market accounting.

Government spending doesn't deal with any of these things.

There Are Tax Cuts, and Then There Are Tax Cuts

One hopeful sign of the new President's pragmatism is his call for a $300 billion tax cut, although the bulk of it would consist of refundable tax credits--giving people money even if they owe no federal income tax. That's still better than Uncle Sam's shoveling out money quickly and wastefully on dubious "infrastructure" projects. Liberal Democrats, though, are criticizing the idea--they can't stomach the thought of letting individuals instead of bureaucrats have direct control over the money.

While Obama's trial balloon has some good parts to it, such as small businesses' being able to expense most capital expenditures up to $250,000, the proposal's effectiveness is mitigated by Keynesian ideology. Giving people money is not the way to get sound, long-term economic growth. The Bush rebates of early last year were a dud in that respect. People liked getting the money, but they used it to pay down debt or stashed it in their savings accounts. Even if they had spent it, the impact would have been a one-time shot.

The flaw here is that such tax changes ignore incentives. Tax rates affect behavior enormously. Low tax rates provide incentive for people to work more productively, entrepreneurs to take more risks and business executives to boost their capital expenditures. Rebates or refundable tax credits have minimal impact in boosting risk-taking and rewarding success.

Obama's idea also ignores the increasing deadweight-overhang of the expiration of the big reductions in the capital gains levy and personal taxes on dividends passed in 2003. If Obama were to announce that these low rates would stay in place and that our business profits tax (the second highest in the developed world) would be sharply cut--say, from 35% to 25%--and that the typical middle-class tax bracket of 25% would be permanently reduced to 15%, that would give the economy a really powerful positive kick upward. And it would end up generating new revenue instead of massive gone-forever outlays.

Earth to Bernanke

Another bad idea that continues to hurt us is the federal Reserve's belief in the Phillips curve, which posits that there's a tradeoff between inflation and unemployment. If you want more prosperity, you have to accept higher inflation; if you want less inflation, you have to accept a less robust economy. Experience has repeatedly shown this theory to be hokum. In both the 1980s and 1990s inflation came down--and we had one heck of a run of prosperity as well.

Yet Ben Bernanke and his fellow Fedsters cling to the idea like King Kong to Fay Wray. The latest example: The Fed let it be known at its December meeting that it was considering establishing an inflation target rate. In Bernanke's strange world the big bugaboo is that a deflationary mind-set might take hold in the U.S. as the recession deepens. Setting a target for inflation "might help forestall the development of expectations that inflation would decline below desired levels."

What planet are these people on? Most folks know that the current price-cutting frenzy of retailers and other producers is intended to move inventory. Deflation comes about when the real value of the dollar goes up sizably and permanently. There's no danger of that happening right now. And as for a "desired level" of inflation--if the Fed did its job correctly and kept the dollar strong and stable, it wouldn't have to worry about inflation or deflation. The Fed's target should be "flation." Period.