Stimulating Nonsense

Feb 13, 2008— -- The hottest buzzword of the day is "economic stimulus." Virtually every politician and pundit agrees the government must act quickly to forestall a recession by increasing consumer spending. President George W. Bush and the Democratic leadership in the House quickly got together on a $150 billion package that also includes tax incentives for business investment.

The Republican and Democratic presidential contenders back "stimulus" too. (Ron Paul is the exception.)

Any government program that wins the support of the political class and media commentators makes me suspicious.

The economy does seem to be slowing, and there was a net loss of jobs in January. The housing industry is sluggish and the credit market tight because of the subprime-mortgage crisis. So, to "get the economy moving," the anointed experts want the government to quickly put cash in our hands. When we rush out to spend it, the story goes, the economy will get out of the ditch.

Interesting theory, but it's hardly new, and it's been demolished many times before by free-market economists. One problem, which George Mason University economist Russell Roberts observed, is that the money that will allegedly be "injected" into the economy is already in the economy. So how can it be a stimulus?

"The politicians are always going to inject some amount of money into the hands of consumers and into the economy, like a doctor giving a lifesaving blood transfusion," Roberts says. "But where does the economic injection come from? It has to come from inside the system. It's not an outside stimulus like the chest paddles or the transfusion. It means taking money from someone or somewhere inside the system and giving it to someone else."

The federal government is in the red. Bush's new budget has a $400 billion deficit. There's no lockbox with $100 billion in it. So to give everyone a tax rebate, the government will have to borrow more money. But that only moves the cash from one part of the economy to another. As Roberts says, "It's like taking a bucket of water from the deep end of a pool and dumping it into the shallow end."

Unless the government cuts spending, which the theory says would neutralize the stimulus, the only other way to get the money will be to raise taxes or to have the Fed create money — inflation — which would raise the price of everything.

How will that stimulate anything but the politicians' short-term approval ratings?

Supporters of the stimulus only consider its "seen" affects. If government takes or borrows money from Jones and gives it to Smith, Smith's spending will be visible for all to see. Not so visible is the "unseen" affect: What Jones would have done with the money but didn't because it was transferred to Smith.

Economists call this the "broken window fallacy." In the 19th century, French economist Frederic Bastiat illustrated it with the story of a boy who breaks a shop window. At first the townspeople lament the loss, but then someone points out that the shopkeeper will have to spend money to replace the window. What the window maker earns, he will soon spend elsewhere. As that money circulates through town, new prosperity will bloom.

The fallacy, of course, lies in the fact that if the window had not been broken, the shopkeeper would have "replaced his worn-out shoes … or added another book to his library." The town gains nothing from the broken window.

This logic is lost on the stimulus promoters. I'm surprised they don't suggest that we prevent recessions by breaking lots of windows.

The other forgotten principle is that consumption can't cause prosperity. Yes, consumer spending is 70 percent of GDP, but consumption is the result — not the cause — of economic growth. You can't consume what hasn't been produced.

Milton Friedman was right. There really is no such thing as a free lunch.

I'm not saying the government can do nothing about the economy. The best thing it can do is get itself out the way. Economies boom when governments remove impediments to production: high taxes, regulations, subsidies, trade barriers, manipulation of the money supply, etc. Removing those should be permanent — not temporary — measures.