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Republican mistake

January 29th, 2009 · No Comments

We try to remain impartial, but sometimes the economics is so clear on an issue that, for the sake of truth, one cannot remain on the sidelines of a political debate.

It’s very simple, really. We need people to buy goods and services, because demand for them has fallen off a cliff. We already have tried interest rates, they can’t be lower than they are, at least not the interest rates that are under the control of the authorities (short-term rates).

So that leaves public policies to stimulate demand. Since the demand shortfall (as measured against what the economy could potentially produce) is very large (more than a trillion dollars), we need to get as much bang for the buck as possible.

There are two ways (and any combination) of doing so:

  • Increase public spending and investment
  • Lower taxes

Now, the simple question just becomes, which route is most effective (we can argue about other aspects of the respective policy options later)?

Economics has a clear cut answer. It’s public spending, because a substantial part of tax cuts won’t be spent at all, they will be saved.

It really is as simple as that, and anyone telling you differently is using either no economics at all or some funny variant.

Paul Krugman, no less, already called the inclusion of a $300 billion tax cut in the stimulus plan wasted money.

Now, the one advantage of tax cuts over public spending is (still in terms of efficiency) that they can be instant, while public spending (especially public investment, like building infrastructure and things like that) takes some time to get organized.

But other parts of public spending can be implemented rather fast, like providing states with financial help so that they can keep services and facilities alive.

Also, anyone travelling through the US by train or plane, and comparing the facilities even to countries like China (still a whole lot poorer) couldn’t come away without the impression that the US could do with some needed upgrade in facilities.

The Republicans seem to be motivated by politics, not economics. And who can blame them, they’re politicians, after all. It’s not surprising that political logic trumps economic logic. Giving in to Obama would help him fulfil a campaign promise of less divisive politics.

More seriously, the political philosophy behind this is misguided, it’s the philosophy that the market is always better, the government always the problem.

The whole present crisis is a textbook case of markets gone mad, and the damage that causes.

Also, public investment has been at the core of much of the US economic success. In the first part of the previous century, it was the excellent (technical) education system (which could do with an upgrade today as well), and how many of the leading technologies of today, like the internet, have originated from public labs and/or funding?

And are countries in which the state takes a much larger piece of the economic pie, like Scandinavian countries, or The Netherlands, really such bad places to live on the brink of socialism, deprived of all economic dynamism? Hardly.

It doesn’t mean that the state should spend indiscriminately, but, this time, the Republicans clearly got it wrong. And it’s a pretty bad time to get it wrong as well. The American public, at least, recognized this in the last elections..

Tags: Credit Crisis