Our Obese Economy

Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works. - John Stuart Mill

David Leonhardt recently wrote a column for the New York Times in overwhelming praise of the stimulus.  Leonhardt goes to great lengths to castigate opponents as political opportunists, visceral reactionaries, or ideologues, but Leonhardt, and many other proponents of economic stimulus - including Paul Krugman - fundamentally misunderstands the nature behind the opposition; it's not about doubting the math or denying that government programs designed to create jobs create jobs.  Reasoned opposition relies on the idea of malinvestments contaminating the economy and the creation of moral hazard inevitably postponing a bigger collapse.

It is first necessary to separate partisan criticism of the stimulus from economic criticism.  The kind of partisan criticism coming from Senator Scott Brown of Massachusetts or Representative Mike Pence of Indiana centers on denying the obvious effects of stimulus or exulting the supposed superiority of the competing Republican stimulus, which Pence claims would have created twice as many jobs at half the price.  This form of opposition is to the Democratic stimulus; it's sort of stimulus penis envy.     

Leonhardt is right to point out that there is a great deal of misunderstanding and ignorance of the effects and circumstances of the last stimulus being distractingly interjected into the current "Jobs Bill" -aka Stimulus 2.0 - debate, but he is totally wrong to assume that one Hoover Institute Wall Street Journal editorial is representative of a unified opposition:

The case against the stimulus revolves around the idea that the economy would be no worse off without it. As a Wall Street Journal opinion piece put it last year, “The resilience of the private sector following the fall 2008 panic — not the fiscal stimulus program — deserves the lion’s share of the credit for the impressive growth improvement.” In a touch of unintended irony, two of article’s three authors were listed as working at a research institution named for Herbert Hoover. 

But reasoned opposition to the stimulus is not about small government or harping on inefficiencies either.  No matter what the government gets its hands on, there will be inefficiencies.  The truth is that sometimes these inefficiencies have less of a macroeconomic effect than market failures or costs of administration for oligopolies, and are thereby warranted.  Proponents of National Healthcare are eager to point to the fact that administrative costs of private healthcare in the U.S. is 31%, almost twice that of Canada's public system.  Here is an instance where the specific market for healthcare in the United States has structural inefficiencies that far outweigh the inefficiencies of government administration in a comparable country's system.  Whether that alone is enough to justify a switch to a public healthcare system in the United States is a complex issue that will not be discussed here; however, it's important to note that this example serves to show that government is not always more inefficient than private markets.  People whining about the ZIP-code scandals or stimulus money being spent on bridges to nowhere have no traction, clearly don't pay attention to the number of zeros, and do not represent reasoned opposition.    

Indeed, everyone can agree that without the stimulus, at least American Express, Bank of America, Capital One, Chrysler, Citibank, General Motors, Goldman Sachs, et al. would have either declared bankruptcy or had to fire a significant number of employees to stay afloat.  Schools, police and fire departments, dutiful RMVs, city halls, and other public sector institutions would also have had to make cuts.  It's clear the stimulus succeeded admirably in keeping a great number of people employed, and, in the case of loans to financial institutions, ushering in a new paradigm of financial rule.  And that's the problem.

Spending money to allow people to keep their jobs that otherwise would not exist may seem like a moral imperative in the short run, but it is pointless, counterproductive, and immoral in the long run.  Take the example of General Motors: despite an apparent demand for more fuel-efficient vehicles, an evident long-term increase in the price of gasoline, and lagging sales, GM and other American companies proceeded with a general strategy focusing on big cars, while Toyota, Honda, Nissan, Volkswagen, and other exemplars of the future of fuel-efficient automobiles had relatively strong sales throughout the recession.  The reason Chrysler failed is ultimately because it made a product that nobody wanted to buy.  Quality cars can be made more cheaply overseas, where the inefficiencies of unions play smaller roles, and business models don't ignore climate change, gasoline prices, safety, and other issues of import.  Propping up Chrysler may save jobs now, but it is pointless in the long run unless there is demand for its product.

The idea of fundamentally flawed companies continuing making inferior products with taxpayer dollars is a good transition to the ideas of malinvestments and moral hazard.  Matt Taibbi has made a career documenting the atrocities of Goldman Sachs and other financial powerhouses, and his words are frankly better than mine:

...The biggest gift the bankers got in the bailout was not fiscal but psychological. "The most valuable part of the bailout," says Rep. (Brad) Sherman (of California), "was the implicit guarantee that they're Too Big to Fail." Instead of liquidating and prosecuting the insolvent institutions that took us all down with them in a giant Ponzi scheme, we have showered them with money and guarantees and all sorts of other enabling gestures. And what should really freak everyone out is the fact that Wall Street immediately started skimming off its own rescue money. If the bailouts validated anew the crooked psychology of the bubble, the recent profit and bonus numbers show that the same psychology is back, thriving, and looking for new disasters to create. "It's evidence," says Rep. (Paul) Kanjorski (of Pennsylvania), "that they still don't get it."

Taibbi is wise to point out that bankruptcy laws were largely ignored in the seemingly arbitrary distribution of stimulus money: as has been said many times, Lehmann was allowed to fail, AIG was not; bankruptcy laws are designed to fairly distribute assets to creditors in the case of a company's failure and have been judiciously employed by courts enforcing contracts and the Rule of Law since Henry VIII.  When it becomes clear that bankruptcy and liquidation is not on the table because of the number of jobs at stake, this creates moral hazard; that is, large financial institutions know that their failure means massive ripple effects throughout the economy, so they know that they will be bailed out with taxpayer dollars anytime they run into trouble; they use their privileged positions to make riskier and riskier bets, and investors of all stripes begin betting on the government's moves or riding bandwagons, instead of relying on fundamentals, resulting in a bubble economy.

Ultimately, I support this particular stimulus only because our reckless behavior got us to a point of no return.  But eventually, there must be massive restructuring and a gradual, gentle purging of toxic institutions.  In the early 1900s, the Roosevelt government took over large conglomerates and broke them up.  We may have to take similarly drastic action once the economy begins growing again.  

While Keynes and Hayek spent most of their careers in bitter disagreement, I think it's possible that the two theoretical frameworks can be reconciled by seeing the former as for efficacious employment in emergency situations, and the latter as our ultimate long-run approach; we must take more minimalist, cautious steps going forward.  Moral hazard and malinvestments have contaminated the American economy, and while there's little we can do towards curbing malinvestments and moral hazard while things remain so fragile, the new Keynesian revival must be tempered with this realization.

To use a metaphor most people are familiar with, the American economy is shockingly, morbidly obese.  High blood pressure and metabolic problems indicate increased risk for heart disease and/or diabetes.  Of course, if the economy has a heart attack or a diabetic shock, it should seek out emergency treatment by going to the hospital.  But a better long-run solution is not to wait until that point, to recognize its problems, and to consistently employ healthy savings and regular free-market capitalism.