This is not a review of history. This column is about mistakes happening right now, passing through Congress right now, under the noses of Americans who should know better.
In 1930, the Smoot-Hawley Tariff Act, signed by President Hoover, passed Congress, and had the subsequent effect of raising tariffs on some 20,000 different imported goods. The ultimate effect was retaliatory tariffs passed by other nations which had a stifling effect on international trade contributing to economic depression that was being felt around the world.
The stimulus bill which just passed the House and awaits Senate approval contains similar provisions to purchase U.S. steel, iron and manufactured goods over imports on large scale projects. Not only will this raise the price tag on these projects, by not considering potentially cheaper foreign providers, but we also risk the return of spiraling protectionist measures which will once again stifle trade and prevent economic recovery through normal market activity.
Due to political pressures from the European Union and Canada, the Senate has since revised the bill to uphold current free trade agreements, but this still excludes nations that we do not have explicit agreements as well as the implicit call to “Buy American.” Washington politicians are bending slightly to foreign political pressure on this one, but they are still taking economic advice from people that support protectionism measures.
Paul Krugman, a Nobel laureate for his work on trade theory, no less, supports protectionism, as he reports in his New York Times column, due to the externalities of policy decisions. An externality is the economic impact on a party not directly involved in a policy decision.
In this case, Krugman postulates, a external benefit is created for foreign competitors when U.S. consumption is increased by U.S. stimulus, at cost of the U.S. economy. Without protectionism, foreign companies could benefit from the fiscal stimulus without having to shoulder any of the debt.
Krugman makes two erroneous assumptions, however. The first is that fiscal stimulus can ever produce long term growth. The second is that fiscal stimulus can produce growth in the presence of a protectionist spiral. These two assumptions are different but inextricably linked.
Fiscal stimulus is the injection of capital into an economy, in this case, by borrowing money or by simply printing it. In either case, while the actual amount of money in the economy is increased, the value of the total money supply has not increased at all, over the timeline at which that debt must ultimately be repaid (in which case the probable scenario is that money will be printed to repay these debts anyway).
Adding capital to the money supply without affecting the value of of the total money supply — which requires new production — is the phenomenon known as inflation. Generally, inflation does have the potential to help get capital flowing through an economy, but the ultimate result is a rise in prices and eroding savings.
The assumption that fiscal stimulus can create economic growth relies on the assumption that giving people money will increase consumption, which in turns increases productivity. However, during FDR’s New Deal, which Obama is attempting to emulate and expand upon, this concept didn’t work. Fiscal stimulus provided new jobs and increased consumption, but the effect was temporary and limited.
At the end of FDR’s first term, unemployment was “down” to 14 percent due to federal work programs, but these numbers rose after programs failed to improve longterm growth. The New Deal also failed to stimulate an innovative environment for businesses, showing that fiscal stimulus failed to stimulate productivity.
Fiscal stimulus has failed, and will continue to fail, to provide real economic stimulus, because it is not creating real productivity but only nominal and temporary appearance of growth, which is all that’s necessary to win reelection. Additionally, debts created by stimulus that will have to be repaid, which will cause an equal and opposite decrease in productivity, after real growth fails.
If fiscal stimulus is to increase economic activity, it would at least need the input of foreign dollars to add real value to the domestic money supply. If we inflate the currency and trade between ourselves, we will all be poorer when the debtor calls or when hyperinflation will make the dollar useless. If fiscal stimulus managed to produce even a temporary increase in the output of production, we would need foreigners to sell these products to. However, in Krugman’s world of the protectionist spiral, this would be impossible.
According to an analysis by the Congressional Budget Office, a non-partisan federal agency that supplies economic data to Congress, released a report detailing how Obama’s “recovery” package will hurt the economy worse than doing nothing at all. The report said short term growth was possible, but that ultimately long term debt would crowd out private investment, causing a drop in GDP after apparent recovery over the next two years.
This outcome is obvious when you consider how business cycles work. Economic bubbles occur when there is misplaced investment into an economic sector with a seemingly unbounded capacity for growth. When reality sets in, the demand in these markets drop off, and overvalued assets must come down in price. This is an economic recession and is the cure for the unsustainable bubble period.
Since the housing and subprime mortgage bubbles were, at least partially, inflated by government interference in markets, the government is attempting, through loose monetary policy and fiscal stimulus, to recreate bubble condidtions. However, they forget that the housing bubble collapsed because it was being financed, unsustainably, through personal debt.
Obama and Congress are hoping to create new growth in the same old sectors — and hopefully some new ones — but government is notoriously poor at picking economic winners, because they have a hard time controlling demand through aggregate economic factors. The government is trying to generate economic growth by creating more debt, when they should be trying to return fiscal responsibility through ensuring economic freedom.
So not only is fiscal stimulus ineffective on its own terms, it is doubly ineffective when faced with protectionist attitudes. The fact that many our politicians, including Congressional Demcorats and President Obama, support the stimulus and protectionism demonstrates that they have little inclination to listen to economic sense. They use the brand “buy American” without considering the high costs to American consumers, instead choosing to pay lip service to the industry and union special interests. They use labels like “recovery package” and “stimulus bill” thinking they can dupe us into believing more bad debt can cure problems initiated by too much bad debt. History tells us that these tricks will only prolong and worsen the economy; turning recession into depression. Isn’t it about time supposedly bright politicians and economists learn from the mistakes of history?
