It takes more than money to revive an economy

Why President Obama’s $787 billion recovery package won’t fire up the US economy — and might even make things worse in the long term.

Sean Collins
US correspondent

18th February 2009

President Barack Obama yesterday signed into law his much-heralded economic stimulus plan. The $787 billion package is the largest US government fiscal measure since the Second World War. Given the huge sums involved, it is remarkable how quickly the plan was approved: in less than a month after Obama took office. The size of the plan and the speed of its acceptance indicate how the economic crisis has changed expectations of what the US government can and should do regarding the economy.

The Obama plan consists of both spending (64 per cent of the total) and tax breaks (the remaining 36 per cent). Spending includes both government purchases, such as infrastructure projects, and direct payments to individuals, such as extended unemployment benefits. The plan also combines short- and long-term measures; while there is some debate as to how quickly the money will have an impact, the Congressional Budget Office estimates that about three-quarters will be spent by 2010.

The passing of the stimulus bill is a clear victory for Obama. He had aimed for a package of this size, and for approval within a short timeframe, and he achieved both. There has been a lot of overheated commentary over the past week about how Obama was in trouble, how he is ‘losing control of the message’, but the plan’s approval was never seriously in doubt. With Democratic Party majorities in both the Senate and House of Representatives, and little internal party opposition, Obama had the votes lined up in his favour from the start. He sought bipartisan support, but only needed three Republican votes in the Senate to avoid a ‘filibuster’ and ensure speedy passage (and, in the event, only three Republicans supported the bill).

Even though the odds were stacked against the Republicans, they did themselves no favours. The debate in Congress revealed that they had no viable counter-arguments. John McCain damned the increase in the government budget deficit as ‘generational theft’, but that argument carried little authority given that Republicans had supported an even greater increase in the deficit when they endorsed George W Bush’s tax cuts, which entail a cost of about $2trillion over a decade.

The Republicans also contended that much of the stimulus plan consists of wasteful ‘pork’ spending. The House Republican leader, John Boehner of Ohio, railed against one supposed environmental outrage: ‘Tell me spending $50million for some salt marsh mouse in San Francisco is going to help a struggling auto worker in Ohio?’ Boehner was assisted by Representative Steve King of Iowa, who waved a huge poster of a mouse on the floor of the House to illustrate the point. But the claim wasn’t true; the bill doesn’t contain money for ‘saving mice’. So, faced with the largest increase in government spending since the Second World War, the Republicans chose to go on the offensive against… fictitious mice. Yes, that sums up the irrelevance of the Republicans today.

Thanks, at least in part, to the lame Republican opposition, Obama now enjoys a dominant position in American politics. But it doesn’t follow that it’s all smooth sailing for him and his administration. Indeed, it remains questionable whether the stimulus plan will achieve its stated objective – to spur economic recovery and create jobs.

Most economic commentators cautiously welcomed the package. Some conservative economists, such as Robert Barro of Harvard, reject it outright (Barro called it ‘the worst bill that has been put forward since the 1930s’), and some liberal economists, such as Paul Krugman of Princeton and the New York Times, said it is not large enough. But the mainstream view was expressed by the Financial Times, which criticised the bill as ‘sprawling and incoherent’, before concluding: ‘It may be the best that could be done, and is a great deal better than nothing. Even if it cannot be admired, it deserves a qualified welcome.’ (1)

A common reaction to the stimulus plan is to say, ‘Okay that’s done, Obama has addressed the economy, now it’s time for him to move on to dealing specifically with the financial crisis’. It’s true that the administration’s financial stability plan will be very important – the amount of support is likely to be in the trillions, and thus exceed the size of the fiscal stimulus package. But before jumping to that plan, it is still worth pausing to consider whether the stimulus package will be as effective in righting the broad economy as many assume.

After all, it is often noted that today the US (and world) economy faces its biggest challenge since at least the early 1980s, and possibly since the Great Depression of the 1930s. Mark Zandi, chief economist at Moody’s economy.com, says that, ‘Even if everything breaks our way, the current downturn will easily be the longest, most severe, and broadest – crossing occupations, industries, and regions – since the Great Depression’ (2).

In the face of these daunting circumstances, the stimulus package is likely to alleviate some of the worst effects rather than fully reverse the downturn. Yes, a $787 billion package will, of course, have a significant impact. And that impact is likely to be larger than the dollar amounts per se, via knock-on effects (the so-called ‘multiplier effect’). But against this, the US economy is also very large (about $14 trillion in GDP annually), and, most importantly, the stimulus spending and tax cuts do not address the underlying problems of the real economy that are at the root of the crisis.

In recent years the US economy has relied on credit expansion to fund growth in consumption and other economic activities. The credit-related crisis means that the economy must undergo an unwinding or ‘deleveraging’ of this credit expansion. And if credit-fuelled consumption will no longer be the economic driver, new sources of growth and job creation are required if there is to be a sustained recovery.

Against this important need, the stimulus package falls short. Very little of it is designed to support innovations in industry; by far the largest part of the spending will go towards programmes already in existence. Where new areas are addressed, the amounts are relatively small – and small-minded. This is highlighted by the spending related to alternative energy, an area the Obama team claims will be a source of future innovation and growth. Many of the ‘green’ initiatives that the package supports are modest, individual behaviour-changing items, such as ‘weatherising’ homes and tax credits for buying hybrid cars. Some $4.5 billion is targeted for rebuilding the electric grid, so as to use energy more efficiently. That sounds impressive – until you learn that, according to an industry study, about $165 billion, plus advancements in communications and information processing technology not yet developed, are needed in order to modernise the grid (3).

Too much of US industry is outdated and unproductive, and requires restructuring if it is to be recast on a profitable basis. Case in point: the domestic ‘Big Three’ automakers, who have already received government bailout money. While the Obama administration preaches patience while the stimulus package takes hold and creates jobs across the economy, it is faced with the immediate reality of the potential demise of GM and Chrysler (and related auto supply industries) – and they are now coming back, cap-in-hand, for more bailout money.

The stimulus plan does not address such fundamental problems of productivity. While it is understandable why there is a consensus on the need to keep the economy from totally collapsing, it could be argued that, in some respects, the stimulus plan may forestall the necessary restructuring process by propping up otherwise unprofitable and bankrupt operations.

Moreover, even if the stimulus is necessary as a stopgap measure, it is storing up problems for the future. After the cost of the stimulus package and the financial stabilisation plan is accounted for, the US government budget deficit is likely to increase to an estimated 13.5 per cent of GDP in 2009 – more than twice the previous postwar high of six per cent under Ronald Reagan in 1983 (4). Keynesians hope that the upturn will provide sufficient surplus to pay off the debt. But given the particular circumstances today – the scale of the deficits, the severity of the downturn and the fact that the private/financial sector is undergoing debt deflation – the increase in public-sector debt is creating a heavy burden that will be a drag on future growth. As Martin Wolf of the Financial Times notes, ‘escaping from huge and prolonged deficits will be very hard’ (5).

At the same time, Obama’s national recovery programme also holds out the possibility of greater tensions in international relations. This can be seen most directly in the so-called ‘Buy American’ protectionist features in the stimulus plan, whereby suppliers for certain items must be American-headquartered companies. These features were watered down in the final version of the bill, but they still remain. Right now, the threat of trade war or other conflicts between nations is implicit, no more than a possibility. But there is an inherent contradiction between seeking to bolster one’s own economy and international cooperation. And this matters because the economic crisis is global in scope, and ultimately cannot be fully resolved solely by national measures.

One of the more striking aspects of the Obama stimulus and financial rescue plans is that, taken together, they represent a major return to the role of government in the economy, and yet there is no ideological rationale provided for this intervention. Since the Reagan-Thatcher era, the prevailing assumption has been that the state generally represents a constraint on growth, and that a free market works best. Of course, this free market has been more of an ideal than a reality, and the state’s economic function has actually continued to increase over time, even before the latest recovery initiatives; but ‘pro-free market’ was nevertheless the prevailing view that informed policy.

Today, however, the Reagan-Thatcher laissez-faire outlook is understood as being too ideological, as in extreme and rigid. In contrast, Obama is often praised for his lack of ideology and his pragmatic approach to problems. So, journalist Ron Brownstein says that Obama shares qualities with two great presidents of the past: ‘Obama’s determination to elevate ends over means could bring him closer in temperament to presidents like Franklin D Roosevelt (who pledged “bold, persistent experimentation”) and Abraham Lincoln, who often insisted, “My policy is to have no policy”.’ (6)

In regard to the economy, Obama is said to favour ‘what works’. While this approach appears sensible (who wouldn’t want ‘what works’?), it has its shortcomings. For one, the emphasis on getting a stimulus package in place quickly meant that the plan was thrown together in a hodgepodge manner. Furthermore, one man’s pragmatic approach can be another’s aimless wandering, and a good example is the financial stability plan – or, should I say, hint of a plan – announced by treasury secretary Timothy Geithner last week. Geithner was slammed by all sides for his vague, detail-free press conference. Last autumn the original response from Geithner’s predecessor, Henry Paulson, was erratic, as he shifted from a plan to buy toxic assets to bank recapitalisation and back again. Geithner (who assisted Paulson at the time) now appears to be following in his footsteps. The administration defends Geithner’s approach as thoughtful, flexible and pragmatic – but the rest of the world sees uncertainty, indecision and inconsistency.

Right now, Obama has tremendous support: his approval ratings are in the 60 to 70 per cent range. New spending projects will expand his base, and polls show that most people will give him a long time – up to two years – to turn things around. However, in spite of talk about a new era of hope in Obama’s America, there is much fear, uncertainty and little expectation. This passive outlook provides Obama with a lot of political room to manoeuvre in the short term, but it won’t be enough to save him if the economy doesn’t ultimately rebound. As Obama and his administration find that economic reality is harder to overcome than the lame Republican opposition, don’t be surprised if they start to define success as simply ‘less bad than what went before’.

Sean Collins is a writer based in New York.