Yesterday’s newspapers brought a study in contrasts. The Wall Street Journal conveyed assessments that the government’s stimulus funding to date has had little effect. New York Times opined that the U.S. economy needs an expansion of stimulus funding—the Times echoes sentiments that some economists’ blogs have been offering for a while. These discussions occur in the midst of realization that the recovery is looking like it has much longer to run. Today, the ability to mount a second burst of stimulus spending is hampered by mounting fears of creditors of the U.S. (read: China) that the AAA-debt rating of the government is in jeopardy, or that the government will simply print money, triggering inflation and a wealth transfer from creditors to debtors. The only other possibility for financing a second stimulus would be to raise taxes, which would have the effect of dampening the stimulus. What to do? This is one of these dilemmas of which worthy case studies are made.
Like any headache remedy, we want a solution that is fast-acting and effective. Plainly, the “American Recovery and Reinvestment Act of 2009” (ARRA) passed in February has been slow in acting. Eight months after the fact, only about one-quarter of the stimulus funds have been spent: $173.2 billion out of the $787 billion to be awarded under the act. Mind you, we want the money to be spent well. But at this rate, it will take more patience to see the stimulus fully deployed.
As for effectiveness, there is some uncertainty about the benefits of stimulus spending—this entails a debate over whether the so-called “fiscal multiplier” is greater than, less than, or equal to 1.0. If greater, then a dollar spent by the government creates more than a dollar’s worth of national income. Keynesian economists estimate multipliers in excess of 1.0.
On the other hand, some economists, such as Robert Barro of Harvard, say the multiplier is less than 1.0. Perhaps stimulus spending, financed by debt, “crowds out” financing for other economic activity. Or perhaps consumers recoil from a stimulus, seeing it only as a time-transfer of wealth: borrow so that we can spend today, leaving it for us to pay the debt in the future by means of higher taxes. Or maybe the projects that the stimulus supports don’t yield much economic value. ARRA is pretty opaque about how the funds will be spent but the Journal mentions projects such as “a $6 million snowmaking facility in Duluth, Minn. or a $3.4 million “ecopassage” to help turtles cross a highway in Tallahassee” that can only raise doubts. ARRA does contain numerous categories of spending on new technology though one might question whether central planners make better resource-allocation decisions than do venture capitalists, entrepreneurs, inventors, and researchers.
The big issue in my mind is this: missing from the discussions is a focus on creating value rather than transferring value. Growth in employment, national income, and economic activity is fundamentally a matter of deploying resources in a way to earn good returns. Better returns flow from improvements in efficiency and generally, from innovation. Economist Paul Romer said it well: “No amount of savings and investment, no policy of macroeconomic fine-tuning, no set of tax and spending initiatives can generate sustained economic growth unless it is accompanied by the countless large and small discoveries that are required to create more value from a fixed set of natural resources.” ((Paul M. Romer, “Implementing a National Technology Strategy with Self-Organizing Industry Boards,” in Martin Neil Baily, Peter C. Reiss, and Clifford Winston (eds.), Brookings Papers on Economic Activity, Microeconomics 1993: 2 (Washington: Brookings Institution, 1993), p. 345.))
I’d like to see an economic recovery policy that lifts the ecosystem of innovation in the U.S. through more investment in research, more new-venture formation, more mobility of financial capital, reduction of barriers to entry for investors and inventions, acceleration of time-to-market, encouragement of risk-taking, reduction of taxes on capital gains, and celebration of inventors and entrepreneurs. We need more creative cooking, to borrow a metaphor from Paul Romer:
“Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. History teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material. Every generation has perceived the limits to growth that finite resources and undesirable side effects would pose if no new recipes or ideas were discovered. And every generation has underestimated the potential for finding new recipes and ideas. We consistently fail to grasp how many ideas remain to be discovered. Possibilities do not add up. They multiply.”
Students will study the current macroeconomic dilemma for years. Given all of the constraints the U.S. faces (high debt, continued instability in real estate and banking, uncertain fiscal multiplier, already large deficits, falling dollar, etc.) it seems unlikely that government will be able to mount a sensible second stimulus. As Romer would say, it cannot simply spend our way out of this recession. Ultimately, we must innovate and grow our way out.
Fortunately, history shows that given time, the right kind of ecosystem, and innovation, such growth may be possible. I’m cautiously optimistic that somewhere in the depths of this trough are the inventors and entrepreneurs who are laying the foundations for the next recovery. Policies of economic recovery must encourage them on with their work.