EXCEPT THAT ISN'T QUITE THE TRAP:

The Stimulus Trap (PAUL KRUGMAN, 7/10/09, NY Times)

For the past 30 years, we’ve been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger.

Hence the danger that the Obama administration will find itself caught in a political-economic trap, in which the very weakness of the economy undermines the administration’s ability to respond effectively. [...]

But there’s a difference between defending what you’ve done so far and being defensive. It was disturbing when President Obama walked back Mr. Biden’s admission that the administration “misread” the economy, declaring that “there’s nothing we would have done differently.” There was a whiff of the Bush infallibility complex in that remark, a hint that the current administration might share some of its predecessor’s inability to admit mistakes.

The GOP actually ought to be considered the stimulus party. For thirty years now it's been Republican dogma to give money back to the tax payers on a massive scale. The trap the UR fell into is trying to stimulate via spending instead.

MORE:
A Second Stimulus Package? Yikes!: India, Japan and the U.S. repeatedly deliver unaffordable and ineffective spending proposals. (Alan Reynolds, 07.10.09, Forbes)

A major study of 18 large economies by Alberto Alesina of Harvard and three colleagues appeared in the 2002 American Economic Review. This paper, "Fiscal Policy, Profits and Investment" found that the surest way to make economies boom can be through deep cuts in government spending--the exact opposite of the "fiscal stimulus" snake oil.

Ireland, for example, slashed government spending by more than 7% of GDP from 1986 to 1989--nearly as much as the 8.4% of GDP the U.S. spends on Social Security and Medicare combined. The Irish economy suddenly switched from a 0.2% pace of economic growth in the early 1980s to annual real GDP growth of 7.2% from 1989 to 2001. With GDP doubling every decade, government debt dropped from 125% of GDP to less than 40%.

By contrast, Japan spent trillions on Keynesian "stimulus" schemes after 1991, doubling the ratio of national debt to GDP. Amazingly, they are doing it still. Japan's "lost decade" of economic stagnation is now approaching two decades with no end in sight.
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Spending cuts ensured much lower tax rates in Ireland, including substantial cuts in personal income and payroll tax rates and the VAT, as well as the famed 12.5% corporate tax. Similar fiscal restraint in India, while it lasted, facilitated cutting the top income tax rate to 30% from 60% at the start of yet another "economic miracle."

By contrast, because of the huge debts piled up by "fiscal stimulus" schemes, Japan felt compelled to add new taxes on consumer spending, land, securities trading and capital gains.

The Alesina study acknowledges that spending cuts were conducive to pro-growth tax policies, but that same study also found that big government spending is inherently bad for economic growth. The authors noted that government hiring lures skilled workers away from private businesses, and so private employers are forced to raise wages even if that means reduced hiring. Artificially boosting labor costs per employee, in turn, depresses profits and investment. They also found that a reduction of 1 percentage point in the ratio of government spending to GDP leads to an immediate increase in the ratio of private investment to GDP, which adds up to 0.8 percentage points after five years. In other words, government spending (regardless of whether it is financed by borrowing, taxing or printing money) will eventually "crowd out" private investment on nearly a dollar-for-dollar basis.

The authors (Alesina, Ardagana, Perotti and Schiantarelli) concluded that fiscal policies that "have led to an increase in growth consist mainly of spending cuts, particularly in government wages and transfers, while those associated with a downturn in the economy are characterized by tax increases."

Posted by Orrin Judd at July 10, 2009 8:24 AM