Echo

Obama's not so efficient stimulus plan

Sunday, January 4, 2009

The $740 billion -$1 trillion fiscal stimulus plan is an all-but done deal. Alongside a serious focus on the creation of jobs - 3 million to be exact - and jobless aid, including unemployment benefits for part-time workers and added health insurance coverage, the plan highlights investment in domestic infrastructure. Obama calls it the American Recovery and Reinvestment Plan, and on it lies hope for a U.S. recovery.

But there is one thing that always bothered me about this plan : if the rise of domestic construction production was to blame for the loss of productivity in the first half of 2000, why are the longer-term spending initiatives centered on construction projects? The focus should be on expanding our most productive sectors – manufacturing and exports - to stimulate innovation and productivity.

According to the NY Times, the American Recovery and Reinvestment Plan will appropriate at least $775 billion toward the following:

  • $140-$200 billion for state budget relief efforts. That is interesting because states jointly require $1 trillion to stay afloat over the next year. States will start cut spending if the bills cannot be paid – this would seriously offset the stimulus (let’s leave that to another post).
  • Extending unemployment benefits that are set to expire in March.
  • Tax credits and cuts for all but "the most affluent Americans".
  • And “billions of dollars for construction projects that Mr. Obama has called “shovel ready.” This could include any type of infrastructure: roads, public buildings, renewable energy, etc.

I understand that investment in capital equals economic growth (anybody who has heard of Robert Solow would know this), but the economic growth path is based on technical innovation, i.e. productivity gains. And if long-term growth is the name of the game, why focus on inefficient domestic construction efforts?

The chart illustrates two measures productivity and payroll growth spanning the years 1990 through 2008. Nonfarm business productivity growth in the 1990s and the 2000s was strong: 1.91% and 2.54%, respectively. Furthermore, there is a negative correlation between nonfarm productivity growth and nonfarm job growth: -0.30 and -0.60, respectively. Productivity tends to correlate with job loss: efficient capital implies that the rate of production for each worker improves, and thus fewer workers are needed to maintain the same rate of production.

The relationship between productivity growth and job loss is most evident in the first half of the 2000s. During Greenspan’s tenure as Chairman of the Federal Reserve Bank, and amid a decade of prolonged productivity growth, the labor market saw its longest contraction in modern history. Nonfarm payroll contracted for roughly 30 consecutive months - 22 months longer than the economy contracted. The prolonged labor contraction was one reason that Greenspan left the federal funds rate at 1% for two years – June 2001 through June 2003 – which led the peak of the housing boom.

Obama's plan: new infrastructure projects equals new jobs, rather than job loss. True, but inefficient.

As the housing sector grew and peaked (measured by prices, the Case Shiller index), manufacturing and nonfarm business productivity declined precipitously. Resources were transferred into the less productive sectors of production, housing and construction, leading to a sharp decline in manufacturing productivity and a surge in construction employment.

As the housing market peaked, the trade balance initiated its steady rise, improving since the second quarter of 2007 on a weak dollar and strong export growth - quarterly export growth averaged 10% (annualized) 2006-2008, up from the 3% average spanning 2000-2006. Resources were re-allocated toward the most productive export industries, mostly manufacturing – industrial supplies, capital goods ex automotive account for 30% and 38% of exports, respectively - and those sectors saw profit growth. But heavy job loss occurred simultaneously, as evidenced by durable goods manufacturing seeing consecutive job loss since June 2007. But job loss will not last forever.

Exports are highly productive, and productivity means profits; profits means new investment and the expansion of those highly productive industries; and expansion eventually creates new jobs and new technologies. It may take a while job growth to resume, but the productive efficiency is worth a grace period. And furthermore, Obama will put in place household tax credits and insurance programs designed to protect workers as they retrain to work in the new industries.

So why are we building roads? The focus on construction and infrastructure as the primary long-term stimulus is highly inefficient. I concur with Joseph Stiglitz, as reported in the International Herald Tribune:

I've been a bit astonished that all the discussion around the private-sector stimulus has centered on infrastructure," he [Stiglitz] said. "Bailouts, too, are aimed at correcting mistakes of the past, so they are backward-looking. We would be much better off spending our money forward-looking. If we spend $700 billion on new technology and innovation, we'd have a stronger, new, real economy. Up to now, the discussion has focused on the sectors that have been mismanaged rather than the sectors that are creating our future.

Rebecca Wilder

10 comments:

Irrational Doomsday Blog January 4, 2009 at 1:07 PM  

Points I agree with you on: Central planning is always inefficient. This stimulus is assuredly going to be very wasteful and economically inefficient. It will help combat unemployment, but it won't work to speed along any recovery.

Points I disagree with you on: You say the economic recovery will depend on this. Conditions are too far gone at this point. There literally is no hope of recovery unless we see huge real GDP contraction, through deflation or inflation, to bring purchasing power back in line with reality.

If there's any silver lining out of the Obama stimulus, it will that it's better than just throwing money into a liquidity trap to be hoarded, as is happening now.

Possible positives would be in the creation of a renewable energy infrastructure. That would help mitigate huge externalities of dependence on foreign oil and pollution. Unfortunately it's too little, too late, in my opinion. We should have been pursuing this a long time ago instead of waiting until collapse.

The second possible positive might be in education, which has been underfunded for a long time. Unfortunately, you could also get desperately needed improvements in education by cutting a ton of waste as well, so I'm skeptical of this part of stimulus not being very economically inefficient.

So I agree it won't work, but nothing else is working either, and it's not politically possible to do nothing at this point. Although it would be very painful, removing this ridiculous level of government intervention would be the quickest way to see a recovery. Now, best case, we're looking at probably close to a decade of central planning dragging the broken economy along. My worst case prediction, as usual, is a currency collapse because the government is totally insolvent.

stephen saines January 4, 2009 at 1:51 PM  

Rebecca! I'd say your latest post addresses many of the points I raised in yesterday's comments.

I like Obama, the World likes Obama, and of course, so does majority US (electoral college convolutions besides), but the 'everything for everybody' approach is going to come to grief.

It becomes a bit frightening, actually, when the economy is stuck in the mud, added stimulus is provided to the engine, but the wheels keep spinning. So the decision is made to go to Nitrous Injection in the engine to further increase power, and the wheels just spin down further into the mud.

Power alone is not the answer. Without traction, there will be no progress.

Uh oh....I'm sounding like Chance the Gardener....

'I like to watch....' lol...what an excellent movie that was.

My thinking is till stymied working on equipment this end, but had to comment on your excellent post. It is a very real topic at this time.

Good post by Blog (I forget his/her entire name) above. I agree with many points.

It's not so much a question of having to intervene (although everything is up for examination) but *where and how* to intervene.

That term "liquidity trap" has reached critical levels in the UK. The US is looking a bit more optimistic, albeit the evidence is so scant as to possibly be white noise.

stephen saines January 4, 2009 at 2:22 PM  

I have visited Mr/Ms Doomsday's blog, and it is interesting reading. I cannot disagree with many points, and I find your profile refreshingly frank, rofl...it is my cynical side!

I do find a weakness in logic, however, when you repeatedly diminish the necessity for 'central planning'.

Like it or not, the US is a union, or 'federation', and with that comes federal powers, one of the most powerful being...The Fed, ironicially private up until relative recent times (if you include the forerunners) and still quasi-private.

The Treasury, of course, is entirely a Federal Entity.

It therefore follows that Central Planning is intrinsic in the remit. Rebecca brings up a very important point, that many individual states are in dire straights financially. Federal Law requiring balanced budgets doesn't help in this instance. Oh the irony!

The situation *does* benefit from Int'l Co-ordination, and so it must on a national level.

You use the same money nationally?

A point I do agree with (with caveats) is in investing in *forward looking* endeavours.

I have some very real doubts about injecting capital into banks, only to see it disappear. I can't help but wonder if 'checks in the mail' ultimately isn't a better way to do this! At least Joe gets his own money, not Daddy Warbucks III.

Rebecca will be pleased to see the Fed's public accountability issue has hit the news, beyond the Bloomberg aspect. My head hurts, and I'm too lazy to Google at this time. but will address that later if need be.

Back to the bench....

Irrational Doomsday Blog January 4, 2009 at 3:14 PM  

To clarify, I'm of the general opinion that central planning should only be used to address market failure.

For example national security, the police, and a lot of infrastructure needs to be accomplished by the central authority because of the freerider problem. The market can't address that. Same thing with externalities. Pollution has to be regulated because the costs are externalized outside of the polluters.

This financial collapse, however bad it is, does not indicate a market failure to me. Yes, it sucks that there was way too much easy credit flowing into the system, and now a correction must be made. But those individuals and firms who did so should pay the price, and allow those who didn't to swoop up and grab the pieces at a discount. That would put a bottom on prices. That would put a turning point to allow a recovery.

Central planning in this sense is just going to distort market signals to allow more good money to go after bad towards unprofitable ventures. Not only that, but the central planning is completely bankrupt as far as I can tell. There is no way we will be able to pay this back as a country. We're going to have to default on social security or medicare and raise taxes greatly if there ever is a turnaround. And that's going to squeeze the economy again. I can't see anything but a perpetual crisis mode form here on out, given the current political climate.

stephen saines January 4, 2009 at 4:32 PM  

IDBlog: Excellent post. We agree on much, and I'm glad you did clarify 'central planning' as to when, not if.

You write:
[This financial collapse, however bad it is, does not indicate a market failure to me]

I agree! I'm a Centrist, and a believer in rewarding endeavour (I guess my spelling gives me away some times, I'm to the North of you). In many ways, your argument becomes mine, on the one hand, it is a very legitimate question as to "where is all the money going?"

On the other hand, that very 'Central Planning', if it is to exist, must act on behalf of correcting as much as possible, both undue upticks and downticks in the economy.

It is steering, and if there are potholes on the road, that is exactly what monetary policy is for, ot correct course to address them.

If the road goes 'off the cliff' (An FT forum today takes that term to issue, but some phrases, hip or not, hit the spot) then no amount of monetary intervention is going to correct the course. The argument remains, however, if it mitigates the impact when bottom is reached.

Ouch!

This nation, Canada, due to internal politics and very ineffectual leadership at this time (a Neo-Con regime, who, like the US, turn out to be the *worst* at Fiscal Prudence)(I'm a Fiscal Conservative) has stumbled upon what I think is an apt course. By being 'off their game' due to a suspension of Parliament, other than some existing programs (e.g: auto bailout), no fiscal stimulus program has been enacted.

Does that worry me? Absolutely, but so does the converse: bailing out anything that moves.
To tie this all back to my comments to Rebecca yesterday, and I'm a real skeptic on this: If the US unemployment figures, which btw, or not directly comparable to many other nations, and probably not historically comparable either, remain in the 8% region, then the US has done very well, all things considered.

I'm sure it will remain the nub of analysis by Rebecca. It is a *very* crucial point.

Lol...on a humourous note....I'm sure these 'word verification' characters you must type in to use your Blogger ID are straight from a book by Rorshach.

stephen saines January 4, 2009 at 6:04 PM  

At the risk of being a 'serial poster', I must add this. If one is a serial poster, there is a onus to remain on-topic, and this ties in very nicely with Rebecca's latest post:
(From the Toronto Star, slightly left of center, and like many commentaries, it is oxymoronic in being *postive* about the general outlook)
[...][ When it becomes apparent that the real economy, as opposed to the financial economy, is in pretty good shape, Main Street confidence will gradually be restored and Wall and Bay Streets will follow. After the tide of credulity on Wall Street went out, the financial services sector shed tens of thousands of jobs. But U.S. employment even in heavy and civil engineering construction – ostensibly hard hit by the housing-market collapse – is holding up well, having shed just 7 per cent of jobs over the past year.

What that means is that even a modest economic recovery this year could yield dramatically good results. "Right now, companies, even if they're doing well, are saying, `Hey, wait a minute. Let's not hire anybody for a while,'" James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, told Business Week late last month. "They could change their minds quickly," Paulsen said, once banks lost their fear of lending freely again and job loss bottoms out.

Certainly in Canada, economic recovery may come sooner than expected. With its long string of federal budgetary surpluses and decade of strong GDP and job growth, Canada slipped into recession late last year in better shape than its G8 peers.

The housing market has softened after six boom years, but in the absence of a burst housing bubble that has driven U.S. house prices down as much as 70 per cent in some regions, the effect in Canada will be more of a flattening in prices rather than a plunge.
[...]
The Obama administration appears ready to spend what it takes to hasten a U.S. recovery that would benefit our U.S.-export-driven economy. Energy and other commodity prices, while down sharply last year, are still holding at their average level over the past five years – a continuing support for Canadian income levels. And commodity prices are expected to rebound by the second half of the year, as demand from a Chinese economy growing at "only" 8 per cent in 2008 (down from 11 per cent last year) returns to pre-2008 levels. And on the supply side, the recession-induced cancellation of major exploration and refinery projects will also exert upward pressure on oil and natural gas prices.

Business expansion is also likely to resume, if modestly at first, following a substantial fiscal stimulus in the Jan. 27 federal budget, rumoured at $20 billion. And the loonie's sharp decline last year is good news for long-suffering exporters.

Looking to the U.S., first the bad news. The U.S. jobless rate could soar from a current 7 per cent to as high as 11 per cent, in a worst-case scenario. As many as 13 per cent of U.S. homeowners with mortgages could lose their homes to foreclosure. Federal pump priming to jolt a moribund economy could see back-to-back trillion-dollar deficits by the end of the next fiscal year. And the bleaker forecasts have the U.S. economy shrinking by 1 per cent to 3 per cent in 2009. Those aren't the kind of projections Canada would wish for its major trading partner.

But the incoming Obama administration's massive stimulus package early this year – as much as $850 billion (U.S.) in spending, largely directed at long-neglected infrastructure – is expected to create as many as 7 million new jobs, in tandem with unprecedented levels of U.S. spending on alternative energy projects.

That short-term boost to consumer confidence will strengthen Canada's stateside market for energy and resource exports. Yet it's the long-term impact that is significant. The U.S. economy will strengthen its competitive advantage from: retrofitted energy-efficient buildings; less congested roads and highways; new high-speed commuter rail corridors; and a surge in medical breakthroughs from record spending on research based on stem cells.

The more optimistic forecasters who see the U.S. pulling out of recession by mid-2009 are making a reasonable assumption, even without factoring in Obama's planned huge stimulus and measures to keep hard-pressed homeowners from losing their shelter. Having begun in December 2007, a U.S. downturn that ends this summer will mark an 18-month slump of far greater duration than most U.S. recessions.

The U.S. malaise would be neither as severe nor long-lasting had the economy not been pushed over a cliff by the global financial crisis in which the supply of credit, for consumers and expansion-minded businesses, dried up almost completely and without warning. And the worst of that crisis has passed, thanks to the $700 billion Congress has been injecting into a crippled lending system.

Time to crack open the champagne? By all means. For Winston Churchill, the bubbly was an all-occasion libation. "In victory I deserve it. In defeat I need it," he said, borrowing from a Napoleon quote. ]

http://www.thestar.com/Business/article/561210
(An analysis of why worst may be behind us_)

An amazingly positive view!

Smack MacDougal January 4, 2009 at 7:24 PM  

First off, it's impossible to "invest in capital".

Capital, from Latin 'caput' meaning head, means being first in line to get paid for renting cash.

That aside, the borrowing and spending approach by Obama should prove to be a failure.

The best approach would be to eliminate all income taxes and cut government by 50%.

States must shrink as well.

Short of this, the better approach would be to shift all investment (cash as capital) in plant and equipment from deduction schedules to depreciation expense.

Meddlers could seek this approach for industries where future growth might happen -- renewable energy.

If anything, rules should lean toward short-term payoffs (making wind towers, solar cells) vs long-term research and development (think cancer drug research that never pays off).

However, picking winners and losers is hard, as consumer preferences and tastes change according to changes in beliefs and needs.

Americans need jobs in self-reinforcing, self-growing industries that enrich us all both from that growth and at the expense of foreigners who would lack competitive advantage in such new growth industries.

Still, the mechanism for achieving this must be market places through tax breaks under our income tax system and not through government bureaucrats picking winning and losers.

The Obama years shall end up being years of major corruption as bribery shall be the order of the day.

Far too much money in the hands of bureaucrats shall become far too tempting for those seeking to gain such money without competition.

Worse, politics shall come into play. Those Americans and regions of the country that support Obama in his 2012 re-election bid shall be the winners of government largesse.

Those Americans and regions who support the other guy shall look like Depression-era Dust Bowls.

If you don't believe it, read up on FDR. He doled out New Deal money only in those parts of the USA where he gained support. He punished all others.

Johann January 5, 2009 at 9:25 AM  

So why are we building roads? To increase capacity? I don't live in the US but i often hear that the average American spends oh so many days per year on congested roads. If new roads can help traffic to flow more efficient that it is a good investment. If you are building the 10th bridge over the same river where the 9th bridge was already unnecessary (as Japan did in the 90s), than you are wasting money.

Btw., in Germany, every truck pays road toll for every mile it uses the highway. There is a tracking device mandatory built into each vehicle. Having this technology would open the door for privatization of the entire traffic infrastructure. Everyone could build roads and collect fees from every user. Freeriding would be punishable by law as today is for example a copyright violation. This would be a technology investment worth considering.

stephen saines January 5, 2009 at 10:36 AM  

Johann:

It is a bit of a misconception outside of the US as to 'roadbuilding'. It is not to build *new* roads, but to repair the crumbling infrastructure built, in many cases, fifty years or more ago.

Remember that terrible bridge collapse across the Mississippi in Minneapolis?

There are literally hundreds of bridges in the US of the same design. There is a toll system of roads in the US, some of them *still* toll years after the initial cost has been paid off. The NY State Thruway is an example.

The US has national network of highways called the Interstate System. The cost is shared by the Federal and the State level, and much of it is in great need of upgrade and maintenance. The original justification for the system, as in Germany, was for national defense. I believe German Lander share in the upkeep of the German system, albeit I might be wrong on that.

The point as it pertains to economic stimulus is this: If you are going to have to invest later to save what you have today, why not bring forward that investment to create work today? It's going to cost you the same when amortized over years, so infrastructure investment is a bit of a no-brainer in terms of spreading work over the years.

The problem with infrastructure investment, as per stimulus, is the amount of time it takes to plan and execute. It is often a year or more from conception to implementation. (For good reason)

We've all heard the adage of digging holes and then filling them in again, just to make work.

That is exactly what must be avoided. As it is, the US, due to the influence of each State having the same fixed representation in the Senate, (two Senators) fiscal allocation is already glaringly inequitable as per population.

The product of that is all too evident in the Senate's last dealings with the 'bailout' plan. Many nations have this characteristic, especially federations, but the US is renowned for it.

As for road tolls nationally, you must remember, the US geographically, is a massive nation (4th in the World? ). There is present discussion about increasing the gasoline tax, but the whole argument of efficiency has taken a back seat in the big picture of economic downturn...save for...and this remains to be seen, Obama's stated altruism of new approaches to the US' energy use.

Emerald January 5, 2009 at 11:19 AM  

Despite the hesitations many business leaders had about what Obama might do once taking office, I think he's taken the right steps and made some great cabinet choices that leave myself and many others in great confidence of his direction. Especially, when looking towards supporting the green energy industry and creating green-collar jobs, Obama is definitely on the right track.

Kevin G. Davis
Managing Director | Emerald Endeavors
For the latest in Green Energy & Clean Technology News, visit www.EmeraldEndeavors.com

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