The National Catholic Review
The crucial role of government stimulus in a struggling economy
Image

With 15 million Americans officially unemployed and the national unemployment rate holding at 9.7 percent, the Labor Department reported a bit of welcome news in April: In the month of March employers added 162,000 nonfarm jobs across every sector but financial services. That number is the highest monthly total in two years. Also, during both February and March investment spending rose, a sign that typically precedes a financial recovery. Those are the positives.

Yet the list of negatives remains long. The number of new jobs in March fell short of many analysts’ predictions, and 48,000 of the new temporary jobs will end in the fall when the U.S. census data have been collected. The official data also varnish the actual circumstances of workers. Nearly a third of the unemployed, for example, have been out of work for more than five months; another three million are no longer counted as unemployed because they have stopped looking for a job; and millions of underemployed Americans work far fewer hours than they would like. Nationally, only 55 percent of adults are currently employed, more of them women than men. Meanwhile, state and local governments faced with depressed revenues are slashing thousands of jobs; the real estate market has not recovered enough to boost construction projects; and consumer spending remains weak.

The Long-Term Costs

Unemployment also sets in motion a set of long-lasting negative effects. When a laid-off worker finds a new job, for example, it is often at a reduced salary, setting back the worker’s total income for years. Seniors remain in the workplace because they cannot afford retirement, while young people cannot find their first job. Even college graduates who enter the workforce during a recession will earn less over their lifetime than those who enter in a strong economy. Joblessness scars workers and their families. It leads to personal indebtedness and delays in education, nutrition and health care. Protracted unemployment can lead to foreclosures and homelessness.

Such observations about the long-term effects of unemployment cast new light on what each generation owes to future generations. For just as government debt is passed on to future taxpayers, the lingering costs of joblessness are handed on as well. That process ought to be reversed. And it could be if the future cost of repaying the federal debt were weighed regularly against the benefits of preventing unemployment. In his State of the Union Address, for example, President Obama proposed small changes in the tax code—a credit for college tuition and a credit for retirement savings—to induce changes in education and retirement security and tax cuts to create jobs indirectly.

In this recession, most of the damage to workers took place from December 2007 to March 2009, when one out of every 20 private sector jobs was eliminated. The rate of destruction was 50 percent greater than that of the recession in the early 1980s. Given the size of the problem, the first federal stimulus had to be large. And it was, at $787 billion. Yet independent assessments credit the Obama administration’s Recovery Act of February 2009 with the generation of more than 2 million jobs. They also predict that the unemployment rate would now exceed 11 percent had Congress not passed the stimulus.

How a Stimulus Creates Jobs

The way a stimulus works is through “the multiplier effect.” Government spends a dollar to employ a social worker, for example. That worker spends a dollar at the grocery store and gas station, which creates profits and wages for the workers and owners there. Consider $100 billion of federal spending in 2009 on infrastructure projects, like putting a new roof on a school or erecting a bridge or retrofitting a public building to save energy. The multiplier effect ensures that the economic impact will exceed the $100 billion investment as the stimulus increases private incomes, raises public consumption and stimulates production.

The central point is this: Spending not only increases the deficit but also boosts economic activity. Activity leads to business profits and rising individual incomes, which lead to increased tax revenues that replenish the federal and state treasuries. According to the Congressional Budget Office, which calculated the effect of the stimulus package, federal revenue would increase by $25 billion over the next 10 years, helping to decrease the federal debt.

The Best Strategies

Economic stimulus can take various forms. The stimulus of February 2009 took the form mostly of tax cuts. Tax cuts are fast and can be targeted to those who need the income boost the most, but they do not create a maximal number of jobs. Rather than spending the money and putting the multiplier effect in motion, people tend to save it or pay down credit card debt. This may be a good household strategy, but it does not make the economy grow.

During a recession, the best strategies include federal increases in benefits for unemployment, Social Security and disability. Why? Because these benefits go to people in lower income brackets, who spend most of it on consumer goods and services that indirectly create jobs. Infrastructure spending is another good strategy with double benefits: as it creates jobs, it also provides lasting public improvements. Federal aid to state and local governments, a third strategy, is good because it maintains existing social services and also enables local governments to assist those communities that need the most assistance.

These last two strategies are similar to those employed during the Great Depression, when the federal government, as the employer of last resort, created public works projects that made stone trails in our national parks, artistic masterpieces in public buildings and electricity for an entire region through the Tennessee Valley Authority.

In January 2010 the Congressional Budget Office measured the effect of various stimulus measures for each $1 million spent (see Policies for Increasing Economic Growth and Employment in 2010 and 2011). It shows that for the five years from 2010 to 2015, assistance to the unemployed would create 15 jobs per $1 million spent, that each $1 million reduction in payroll taxes for employers could create 16 jobs and that U.S. infrastructure investment could create 10 jobs that would also put solar panels on post offices, restore national parks and make other civic improvements.

As for federally funded public works, the president’s 2011 budget includes the skeleton of such a program, with increased funding for highway construction, promotion of energy efficiency (like environmentally friendly home weatherization) and scientific research. If implemented, it could boost job growth and ensure long-term benefits.

My own pet jobs proposal would be conversion of the nation’s road signs to the metric system. Learning the metric system would help the nation to compete globally. Just think of the money businesses now waste by having to make two sets of products and written materials: one for U.S. customers and another for everyone else who uses the universal metric system.

Emergency Measures

Concerns about the growing federal deficit are real, but should be seen in the context of the recession. It helps to consider unemployment in medical terms. Viewed thus the federal stimulus is like emergency treatment. When an overweight smoker has a heart attack, the doctor temporarily puts aside long-term solutions, like better diet and exercise, in order to address the failing heart. This is the state of the economy now. Government needs to save the patient first and then prescribe the long-term rehabilitation (deficit reduction, stricter regulation of the financial sector, stronger government guarantees for retirement savings) to stave off future crises.

In recent history, governments have used deficit spending to save private markets when they failed. Given the high rates and protracted costs of unemployment, it is hard to understand the fierce opposition among some in Congress to policies that for over 70 years have reduced unemployment. The opposition appears to be deeply rooted in a political philosophy that favors small government, even if it costs workers their jobs.

In January the Obama administration took a step backward when it announced a federal government spending freeze. The freeze is popular among those worried about the deficit, but it is not a helpful way to create jobs or stimulate the economy. As an economist, I commend the president’s Recovery Act and budget proposals for including deficit spending. But I would argue that the nation needs a more confident, aggressive frontal attack on unemployment—a new stimulus package large enough to ensure that the resulting debt will be paid back.

Deficit spending is investment spending; it expects a return. Though anti-deficit political forces want to make this a paradox, it is not. It is basic math. Deficit spending today solves deficits tomorrow. Businesses engage in deficit spending. Households do it. So do governments. Borrowing today to create jobs yields more tax revenue in tomorrow’s healthier economy.

p { margin-bottom: 0.08in; }

Read this article in Spanish. Translation courtesy Mirada Global.

Teresa Ghilarducci is the Bernard Schwartz Professor of Economics at the New School in New York and author of When I’m Sixty Four: the Plot Against Pensions and the Plan to Save Them. She taught economics at the University of Not

Comments

Michael Bindner | 4/27/2010 - 2:30pm
What is needed is sustainable change, not emergency measures. The biggest change should be to make sure that workers are paid a living wage. This cannot be done by mandate alone, since even attempting this would either result in exclusions for small business (rendering the mandate ineffective) or in small business going out of business. Therefore, living wage measures must come through the tax system.

The Child Tax Credit and numerous other credits and exemptions do this, but at the cost of complexity. An effective credit would be $500 per month per child added to a higher minimum wage (so no one is paid primarily through tax credits) - with a state credit from $300 to $500 per month per child.

The best way to deliver the credit would be to shift most tax filing to employers from employees - ending the deductibility of wages for employers while abolishing the income tax for all but the wealthiest. Most tax filers who think the government is too intrusive would enthusiastically favor such a reform and it would truly not add much to the burden of employers - since they do the majority of tax reporting and collection now. This proposal would merely end the duplicate filing (although the government could mandate a statement on tax credits paid go to every employee along with a confirming government copy to make sure that employers don't pay one thing and report another).

The federal credit could be easily paid for by ending the child exemption, the home mortgage interest deduction and the property tax deduction. The mortgage interest deduction mostly favors the wealthy who would likley buy their McMansions anyway - so this change would be a win for the home building industry (although many builders like building high end homes more than moderately priced homes - however the tax system should not subsidize their habit).

This change would put more money in the pockets of the poorest, who are most likely to spend it and thus put more people to work. It would set in motion a virtuous cycle that would end the recession and give policy makers a tool to quickly end other downturns (by simply raising the Child Credit to give more to families).
JOHN WALTON MR | 4/23/2010 - 2:16pm

If government stimulus were so effective, why did unemployement remain so high throughout the depression?  In fact, the tax policies of the Roosevelt snuffed out a nascent recovery in 1937. 

There is no "greater than unity" multiplier effect unless a dollar of government spending is used more efficiently than it would be employed in the private sector (as Kevin Murphy of the University of Chicago has so ably demonstrated.) 

This Administration's stock in trade is "uncertainty" - Obama used this tactic as a succesful campaigner and organizer on the South Side of Chicago, and today employs it skillfully in pursuing his social agenda.  Uncertainty, however, has an estimable economic cost, borne out in terms of deferred or lost capital expenditures and hiring. Of course, Obama never ran a lemon aid stand, so we can't expect him to use some statistical methodology with all sorts of greek letters lying on their sides to estimate demand under conditions of uncertainty.  My suggestion: zipper the lips, step out of the way and let the kids play with the ball.  Employers don't need someone with the personality skills of Larry Summers, or the in depth knowledge of the tax code a la Tim Geithner to show them how to hit the ball.