The Limits of Deficit Spending

The unemployment rate is weighing very heavily on the economy, and on our politics as well. People are getting impatient: the unemployed, of course, but also the people who worry about losing their job, the people who do not count as unemployed because they have given up, the people who are employed and expect to remain employed but have seen their wages, their hours, or their benefits--or all three--slashed. The government has almost given up trying to do anything serious to speed economic recovery and reduce the unemployment rate. The Republican Party has waged an effective campaign against the $787 stimulus bill that was enacted back in February '09 and that is now regarded (mistakenly, as it seems to me) as an economic as well as a political failure. It was a disappointment and only a partial success. It was late in coming, poor in design, slow in execution, poorly explained by our articulate president and his economic advisers, and ineptly defended with unsubstantiated claims about the number of jobs saved. And it has collided as it were with other deficit sources, which has fed concerns with the long-run health of the economy.

The $787 billion has not yet been fully spent, so there will be stimulus spending this year. But predictions are that unemployment will remain at about 10 percent. That doesn't mean that the stimulus was or is a failure, for without it, the unemployment rate would probably be higher, though no one knows how much higher.

The administration's attempts to quantify the effect of the stimulus on employment are unconvincing and no longer widely believed. With unemployment expected to persist at such a high level, indicating a great deal of unused productive capacity in the economy, there is a case for further stimulus, and it is being vigorously pressed by liberal economists such as Paul Krugman. But the administration appears to have lost its case for stimulus spending in the court of public opinion. The only additional stimulus spending will be, it seems, essentially empty gestures of concern. To that camp belongs the $33 billion job-subsidy program that the president has proposed to Congress. If it is enacted, employers will be entitled to a $5,000 tax credit per worker hired if the hire increases his number of employees, and to an additional subsidy for raising wages by more than the rate of inflation, but the total amount of subsidy is limited to $500,000 per employer.

The program is unlikely to have an appreciable effect on employment. It is too small. It will either be gamed (as by firms that fire and then rehire), or the procedures created by the legislation to prevent gaming will entangle the program in red tape, delaying its implementation and perhaps rendering it largely ineffectual, like the program to encourage mortgage modifications. It will not be targeted on industries and areas of the country in which unemployment is highest.

But the biggest problem with the job-subsidy program is that it is fundamentally misconceived. The Keynesian theory of stimulus (the only theory that makes economic sense) is that if private demand for goods and services falls substantially below the economy's productive capacity (as it has done), government can replace the shortfall in demand by increasing its own demand. It can buy roads and airports and military equipment with borrowed money (so as not to take money out of people's pockets, in the form of taxes, and by doing so depressing private demand). And it can borrow cheap, because consumers are saving more than usual, and with demand weak, businesses are borrowing less than usual. So the private demand for credit is weak, and interest rates therefore low. The surge in government demand increases production, and increased production results in increased employment.

The job-stimulus plan is not aimed at increasing demand, and therefore is unlikely to increase employment. For example, if a company is producing 1,000 widgets a year with a work force of 30, and it adds a 31st employee and thereby earns a $5,000 tax credit, the company's total costs will have risen by the wages and benefits that he pays the new employee minus the $5,000. But his sales will not have risen. Participating in the job-subsidy program will actually reduce his profits (revenue minus cost).

The job-subsidy plan can be understood only in political terms. The country is riled up about the unemployment rate, and so, demands that the government do something. So it is doing something, just not anything that will affect the unemployment rate. If as we all should hope the rate falls, the administration will claim credit, pointing to the job-subsidy plan.

Politics aside, the mounting federal deficit should worry the advocates of major new stimulus spending more than it does. The deficit this past fiscal year (which ended on September 30, 2009) was $1.4 trillion, and the administration itself is predicting a deficit in the current fiscal year of $1.6 trillion, which will bring the nation's public debt (the critical component of the national debt) up to $9.1 trillion. The administration continues to unsettle the general public and the business community alike by vowing to continue pressing its ambitious (and immensely costly) health-insurance plan; and Medicare and Social Security spending continues on a seemingly inexorable upward path. Without being able to predict the future beyond a few months, no one can be confident about knowing what measures, if any, can prudently be taken to promote economic recovery and reduce unemployment.

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