Sunday, January 11, 2009

Obama's bang for the buck

Obama’s economic recovery plan has begun to feel like the kitchen sink approach to fiscal stimulus. Anything goes... tax credits, spending on road repair, new computers for schools or the expansion of broadband access. And just wait for Congress’ inevitable “cherry on top”!

Interestingly, the bulk of the measures announced as part of the “American Recovery and Reinvestment” plan can be found in Obama’s pre-election promise on the future of the economy. But then, may I ask, is it a stimulus we’re getting or the entire economic agenda of the Obama-Biden ticket, only unfunded?

The latter, more or less. But let's go back to the beginning. Economic theory is not conclusive on whether discretionary fiscal stimuli can counter the impact of a downturn. (The IMF summarizes why here). By “discretionary” is meant anything over and above the “automatic” fiscal expansion that tends to come with recessions (e.g. as tax revenue falls and, say, spending on unemployment benefits rises).

Still. Since it’s easier to say you’re doing something, than to try to explain the meaning of an “automatic stabilizer”, here are a few guiding principles for discretionary fiscal stimuli:

First the three T’s:

• Timely (well, we’ve kind of missed the boat on that one, but let’s assume “better late than never” applies);
• Targeted—to get the money to those who need it most and/or those likely to spend it faster.
• Temporary—with clear sunset clauses to ensure debt does not go through the roof.

On top of these, the IMF threw out a few more in a paper last week:

• Lasting—the government should promise that the measures will last until the economic begins to recover, to reassure the public that it won’t abandon ship half way through.
• Diversified—since we’re pretty clueless about what works best, the IMF suggests trying a bit of every (wise) measure in the hope that some will work.
• Sustainable—again, to avoid the undesirable consequences of skyrocketing debt, such as higher interest rates, inflation and loss of confidence.

The idea behind all of these is, of course, to get the biggest bang for the buck.

So how does Obama’s plan fare? I’ll focus on the bigger items:

Income tax cuts: A $500 rebate for individuals and $1,000 for families, first stage of Obama’s electoral promise to cut taxes for 95% of American households. Targeted? No (95%!). Temporary? No. Bang for the buck? Perhaps, by virtue of being a permanent increase in disposable income instead of a one-off tax rebate that may be saved. Sustainable? I hold my breath (for at least a couple of years) till the cuts get funded.

Tax credits to companies for losses incurred in 2008 and 2009. An appealing idea, one might think—giving companies a bit of cash at a time when it has become a scarce commodity. But... The measure is highly distortionary, favoring troubled companies over profitable/better managed ones and, indeed, those least likely to hire or make new investments. Little bang for the buck.

A (refundable) $3,000 tax credit to companies for each new worker they hire: Hard to see how a temporary tax credit would dominate a bleak economic outlook in firms’ hiring decisions. So the measure is likely to be used (and abused) by firms who would have hired people anyway. Little bang for the buck.

How about Obama’s spending plans? Like, investments in alternative fuels, a new digital electricity grid or the expansion of broadband lines across America?

In theory, government investment has a bigger bang for the buck than tax/revenue measures: It has a direct effect on demand and long-term supply-side benefits (assuming it’s not spent on bridges to nowhere). In practice, lags in project execution and the difficulty in identifying good-quality projects soon enough makes it less effective in countering a downturn.

One way to increase the “bang” is to frontload the execution of existing, productivity-enhancing projects. This is partly what Obama said he plans to do, with $25 billion going towards the repair of roads, bridges and schools.

But how about the rest? Has the Obama team had the time to identify specific “worthy” energy/infrastructure projects that could start off as early as March? Are they indeed “worthy” enough for the private sector to take over/participate in their financing once markets stabilize? Or would the government need to keep up the subsidies till death do us part?

More generally, is Obama ready to commit, along with his “stimulus” package, to a medium-term budget framework? One that explicitly shows the meaningful reduction in spending (or increase in taxes!) that would be mandatory once the economy gets on its feet, in order to keep the debt at bay?

Ultimately, what creates jobs is confidence in a brighter economic outlook, and the availability of private financing at a reasonable cost to fund productive investments and create jobs.

A crucial step to this end is a credible commitment to keep the debt under control, at a time when (per the estimates of the Congressional Budget Office) the deficit will reach at least $1.2 trillion this year, before any stimulus plan is counted. Another is to fix the financial markets.

If you ask me, I’d rather see a much smaller stimulus package. One that focuses on safety nets (e.g. health and unemployment benefits to the unemployed); and on the effort to resurrect the financial markets and reduce the cost of private financing from its current obscene levels. Throw in some money to stem foreclosures for fairness’ sake, if you please. But beyond that, I’d rather see all the PhD talent of the incoming economic team devoted to designing appropriate structural reforms that improve the incentives of the private sector to function efficiently.

Meanwhile, Barack, if you’re having trouble with the meaning of “automatic stabilizer”, I can help with the speech. I promise to make it short, succinct and simple.

Glossary: automatic stabilizer, discretionary fiscal stimulus, bang for the buck


Anonymous said...

What you overlooked is the cost to produce the jobs: about 194K per job @$775B/4 million.

O has been sold a bill of goods by his economic team. This plan isn't worth the paper on which it was written.

Bob_in_MA said...

"If you ask me, I’d rather see a much smaller stimulus package."

Yes, your summation was spot on.

And here's a really self-serving reason for Obama & Co. to ratchet down the scale and promises their making: this won't bottom until asset prices bottom, so trying to turn things around too early is just going to be a costly failure and give the GOP ammo for the 2010 elections.

The arrogant certainty these display is simply absurd.

Anonymous said...

care to spell out what kind of structural reforms might be most effective in the current context? a neoliberal agenda feels a bit at odds with the times, so to speak --

i am a bit more inclined to think that at this stage supporting demand is important -- and that there is no real way to revive investment demand in the short-run so long as consumer demand is falling/ there is plenty of capacity globally. so even a big stimulus has little risk of crowding out private investment ... and I don't quite see what the structural reform agenda would include other financial sector restructuring. health care perhaps. but a big reworking of the health care system isn't obviously a stimulus ...

am curious what you have in mind.


Harleydog said...

While I agree safety nets will be needed, have we not learned that "meddling" and the "we know better crowd" is just garbage and hubris and exacerbates the problem.

Regarding PhD talent, never forget remember those letters still stand for piled higher and deeper.

Great blog and continued success to you.

Prudens Speculari