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Thursday, September 23, 2010

Has the Obama Stimulus Package Failed?

Well, it certainly failed to keep unemployment under 8% as promised. My guess is the administration failed in part to calculate the cutbacks at the state and local level caused by severe cutbacks due to the deterioration of tax revenue. But overall it was constrained by the diversity of analysis at the time (remember, some well-known economists were still predicting a "V"-shaped recovery?) and because parts were turned into tax cuts. (Little consolation if as you as an individual or corporation have no income to be taxed.)

Then there was politics. The stimulus package was passed in late February 2009 with the help of Susan Collins and Olympia Snowe, both Republicans from Maine. After Obama’s inauguration on January 20, 2009, the stock market continued the “free fall” that began under George Bush in 2008. Rush Limbaugh, John Boehner, and others touted as spokesmen of the "right," frequently commented that the “stock market must not like the prospect of “Obamanomics.” At the time, I thought this was hypocritical at best as the free fall began as a result of the meltdown of the financial system triggered by Joe Cassano, AIG, Goldman Sachs, etc. due to a lack of proper regulation on the Republican administration’s watch, fueled by years of easy money.

After the Stimulus Package was passed, and “markets” could be certain the administration was solidly behind the economy, the stock market began a run that has restored approximately 13.5 trillion dollars of mostly American wealth. Strangely, we haven’t heard anything about this from Limbaugh, Boehner, Beck, etc. It stands to reason that if the stock market is an indicator of how the market likes a President’s economic policies, it should be evident, that at least relatively speaking, the stock market has “liked” Obama since March of 2009 when the stock market advance began.

For my own part, I think this logic is largely overblown, but if the "right" wants to use this logic when they think it benefits them, they should use it when it doesn’t.

When Obama was inaugurated in January 2009, the U. S. economy lost 750,000 jobs in that month. As he had just taken office at the end of the month it would be hard to blame him for this. The job loss wasn’t stemmed the following month. These things usually take a while, 2-3 quarters even after policies change, and a new president can do little without the approval of Congress. (A similar example would be the Reagan administrations struggle with the unemployment situation it inherited from the Carter administration – see below.) In fact, it took about 12 months to stem the monthly job loss, so we went from -740K per month to zero in 12 months. Failure? You be the judge.

The graph below from the Reagan era shows the unemployment results of Reagan’s attempt at economic stimulus, which was largely based on massive tax cuts and then was helped by the Fed's easing of real interest rates by 4 percentage points from record high levels. (The Fed Funds rate briefly broke above 19% in the summer of 1981 with inflation of 10%, falling to under 9% by spring 1983 with inflation of 4%, so from "real" 9% to "real" 5%.) In fact, it was Paul Volcker and the Fed who broke the back of inflation, not Ronald Reagan. No help this time: the Fed lowered interest rates in 2008, and by the time Obama took office they were at historic lows with no further cuts possible.

Most economists agree that in times of economic recession, tax cuts are primarily saved or used to pay off debt by wary consumers (or held onto by the corporate sector for similar reasons). As a consequence, tax cuts are NOT as stimulative as public works spending or (in the opportunity cost sense) by providing help to state and local government so that they wouldn't fire people. In addition, once the economy eventually turns around, tax cuts are difficult, if not impossible, to repeal. This results in institutional deficits year after year. The "right" may claim that this is the way to "starve the beast" but under Bush, when Republicans controlled both the White House and Congress, they showed no ability to actually do so. [MS: They appropriately complain that government is inefficient, it's inevitable because it's asked to do things that the market typically can't do because output can't be measured or a price can't be attached. That's why government reform is even harder than corporate restructuring. But apparently the Republicans under several presidents judged that most of what government was doing was necessary.]

The Reagan tax cuts did not have the same stimulative impact as the Obama stimulus has had so far, as the graph suggests. [Economists insist on complicated models, but this is certainly a good start: MS] It could be argued that the recession Reagan inherited from Jimmy Carter was nowhere near as serious as the one Obama inherited from Bush. The financial system had not melted down and only one automaker was near bankruptcy. Reagan’s voter approval rating was equally as bad as Obama’s at this stage of their administration, as an impatient electorate expected things to rebound faster. Reagan lost 27 seats in the House to the Democrats in his first midterms. His approval rating rose substantially when he was shot by John Hinckley, Jr., and he was rescued by an economy that started to improve, based on pent up demand, fiscal policy and lower interest rates, before his second term election, which he won decisively. Previous to being shot, Reagan's approval ratings were in the range of what Obama's are now.

It is interesting to note that Reagan was nowhere as "right" as people think. He was once President of the Screen Actors Guild, a “union” full of “known leftists,” to borrow a phrase. He established a huge entitlement program in California by proposing and signing a law that provided 2 free years of junior college to California residents. He gave the country a compassionate but inefficient form of universal health care in the form of the Emergency Room Mandate (The Emergency Medical Treatment and Active Labor Act) that he signed into law in 1986. He granted amnesty to millions of illegal aliens. He deregulated the airline industry, beginning a chain of losses and unsuccessful restructurings of such magnitude that the industry has from its inception through today now lost money on net. His deficits eventually swamped George HW Bush, and led to the election of Bill Clinton. (Arthur Laffer, Reagan’s favorite economist and author of the Laffer curve, refers to Clinton as the most conservative president, in terms of economics, of the modern era.) Reagan's deregulation led to other problems. The S&L crisis initially cost taxpayers $600 billion, an amount lowered to $250 billion because the government then closed down most of them and did a good job of selling assets at auction. That crisis didn’t do the elder Bush any good either. Nor did the "grass roots" 3rd party candidacy of Ross Perot, the Tea Partier of his era.

In the last few months, things have stagnated. Job creation has not gained desired traction. We have been stuck at zero – though that sure beats the alternative we'd have absent a stimulus package. The economy has been hit with the double whammy of the European Debt Crisis and the BP oil spill. On top of day after day media coverage of bad news comes economic data that reflected our position at the bottom of a large trough and looked especially bad compared to last year's numbers. Yet last year’s numbers were juiced by an economic stimulus called “Cash for Clunkers”...as anyone who reads this blog has seen discussed in detail.

The fact is, we desperately need Obama’s latest stimulus proposal. Yet, the 
Republicans, who have seen the same graphs I have included here, will obstruct this legislation in any way they can. It remains to be seen if Collins and Snowe will vote with the Democrats on this. The LAST THING the Republicans want is an Obama triumph of any kind going into the midterms, regardless of what might be for the good of the country. Obama was shoved into a ship foundering in deep water when he came into office. He's steered it towards shore, but now partisan electioneering has cut off the engines. Which direction will the boat drift? – we don't know, but if it's not towards port, the Republicans must share the blame.

The closest thing to a Republican plan is the alternative budget they proposed a few months back, a document hopelessly short of detail. Otherwise, they have chosen the “Party of No” approach.

Please note that I am an amateur economist at best, and think of myself as "conservative" (on that dimension, I'm a typical [though now former] car dealer). I have studied Keynes to a degree. I am also familiar with an alternate theory of economics some call the "Austrian School." My understanding of the Austrian School theory is its bottom line of “laissez faire” economics, a kind of “natural selection,” survival-of-the-fittest approach. It makes for an interesting point of view for discussion over a beer. But we haven’t seen it at work since Herbert Hoover. Ron Paul would be a Austrian school advocate, I believe. "Austrians" would have let the banking system and our industrial base collapse in a process they call “creative destruction.” Well, as an auto industry person now consulting on the financial end of the industry, I could see how that would lead to destruction, an unreasonable and unnecessary cost. The Pentagon was fully aware of this and played a part on convincing Bush the second to step in. But there was no discussion among proponents of letting GM and Chrysler liquidate of how long rebuilding would take, of how new institutions could arise from the ashes in my lifetime. Creativity isn't a always matter of inspiration, it's a product of years or decades of hard work.

To be clear, it is NOT my understanding that John Maynard Keynes advocated ongoing deficits; he was a monetary economist and worked hard to keep the financial sector from bringing down the "real" economy where most people worked. In fact, he would have preferred the establishment of a “rainy day” fund before advocating systemic deficits. WW2 represents the ultimate Keynesian stimulus -- FDR was too timid on his own to use Keynesian principles in his public works projects, which combined with restoring a modicum of financial stability only reduced the unemployment rate during the Great Depression from 25% to 17%. None of us are old enough, other than perhaps my father, to remember first hand, but it is sobering to read of the cutbacks because of the political climate surrounding FDR’s campaign for reelection. In addition, the Supreme Court stopped some of FDR’s public works initiatives, while renewed monetary stringency (for reasons that sound chilling given current debates) led to a spike in unemployment in 1937. We really don't want another world war to pull us out of the doldrums.

Even Republicans remember the Great Depression. Tent camps of desperate citizens were called “Hoover Towns.” At one point, 28 states didn't have a single bank open. It took the Republicans a generation to regain the White House, and even then it took a popular war hero like Dwight Eisenhower to accomplish that. The Right Wing and the John Birch Society referred to Ike as a “socialist”, and a “tool of communism.” Ike inherited a wartime tax structure with a top rate of 91%. With hundreds of thousands of young men home from war and needing a job, Ike embarked upon a Keynesian style public works project called the Interstate Highway System, instead of providing tax cuts to bolster the economy. The rest is history and the country was transformed for better or worse.

Another example of deficit spending and Keynesian economic stimulus would be the expansion of railroads after the Civil War. Tax revenues were at low ebb and the country was deeply in debt. We "spent" by giving away land, something that didn't show up in the budget. That and 30 year government bonds financed the transcontinental railroad. Most people would say the investment paid off; even folks who maintain, “The government is the problem, not the solution” might agree. There is an ideal balance to be achieved between “socialism” and “laissez faire” to achieve the desired results. Government is the price we pay for civilization.

To return to the opening topic. If only Obama had inherited a situation that didn’t already included accelerating deficts, burgeoning unemployment, and diminishing tax revenues. But he inherited what he inherited. Nobel Prize winning economist Paul Krugman calculated that the stimulus should have been twice its size. Obama agreed, but recognized that a larger stimulus was politically impossible. As a consequence he chose to let the original, bloated Bush 2009 budget go through without "pork scrutiny" and associated cuts. This represented the breaking of a campaign promise. But cutting government spending in the face of recession leads to Depression. Isn’t this the lesson of the Great Depression and the Hoover era? Does anyone really think the Republicans want to go there again with them in charge? At the moment they are trying to have their cake -- decrying stimulus and money already spent to avoid a crisis -- and eat it to, since as the party of "no" there will be no policy bearing their name.

Sometime in the next few years the government needs to take steps to get rid of systemic deficits. The Republicans across several administrations showed that cutting "their way out" won't work. (Indeed, if you look at the size and composition of the budget, every non-defense Federal bureaucrat could be fired and we'd still have a budget deficit.) Growth will help, a rebound in incomes and employment would improve the revenue side, the "cyclical" part of the deficit. I don't like it, but basic arithmetic still shows the bottom line has to include ... let me phrase this carefully, tax enhancements.

So you be the judge. Did the Obama stimulus package fail? How does the Obama rebound compare with the Reagan era? Does anyone have a suggestion on what Obama could have done to turn things around more quickly, especially in light of Republican opposition?

Marketminder post with additional graphs

David Ruggles [with editorial asides by Michael Smitka]