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Will It Work? That’s a Tough Question.

February 16th, 2009 . by economistmom

I’ve been trying to think (often out loud here) about the variety of things the “recovery and reinvestment” (don’t-call-it-just-”stimulus”) package is supposed to accomplish.  And now that it has passed and will very soon become law, the politicians are all trying to position themselves so that whether it “works” or not, and whatever parts of the package they supported or not, they’ll end up looking like they knew best.  They may all get away with this political-posturing strategy, because the goals of the package and the policies that combine to make up the total package are so varied, that no matter where the economy goes from here, it’s unlikely we will come to definitive conclusions about which policies “worked” and which did not.

It strikes me that the ways the recovery package is most likely to make a difference are in fact the ways in which we least know how to measure the value.  I see the goals of the various fiscal policies in the package as falling into four categories:

  1. Boost short-term economic activity:  Increase purchases of goods and services (remember, GDP = Consumption + Investment + Government purchases (+ net exports)), above what would otherwise be the case.  This means as immediately as possible putting idle productive capacity to use–i.e., putting unemployed workers to work, getting shut-down plants going again, producing those new goods and services to meet new demand.  It’s with this demand-driven goal that the indirect strategies (transfer payments or tax cuts to households and businesses) are less likely to work as well as direct government purchases of goods and services, particularly if those indirect payments are not well targeted to households and businesses most likely to spend their new income on new goods and services (that they otherwise would not have bought).  Although aggregate GDP is easy to quantify, evaluating the effectiveness of the policy strategies toward the goal of immediately boosting GDP, all else constant, is not so easy.
  2. Assist American households who need that help the most:  Through safety-net spending programs (unemployment compensation, health insurance, food stamps, etc.) and tax cuts that are steered toward lower-to-middle income households, government can replace some of the lost income of households most hurt by this economic downturn.  For this goal in isolation, what the households choose to do with this assistance (whether they consume it or save it) doesn’t matter.  Even if a transfer payment is ineffective in boosting short-term GDP (because most of it is saved instead of leading to new purchases of goods and services), it will still boost the individual households’ economic well-being–and the welfare of society as a whole if one of the things we care about as a society is the well-being of the worst off in our society, or the distribution and not just the aggregate size of our economy.  Clearly, it’s easy to see which parts of the recovery package directly address this goal of assistance, but the value we place on this goal is not easily quantified in economic terms, as it does not show up in aggregate GDP.
  3. Promote longer-term economic growth:  Increase national saving and investment to increase our economy’s productive capacity (in contrast to the short-term goal of employing idle capacity already in place).  Fiscal policies toward this goal should encourage growth and improvement of the stock of physical and human capital, above what would otherwise be the case.  Building up a more productive labor force (healthier and better-educated workers) and a more productive physical capital stock (more efficient and sustainable technologies and infrastructure) will lead to a larger aggregate economy (higher GDP) over the longer term.  It’s with this supply-side goal that the deficit financing of policies makes those policies less likely to work, because the enlarged deficits represent negative public saving that offsets any increase in public or private saving that is otherwise encouraged by the policies.  (CBO’s macroeconomic analysis of the recovery bill highlights this point.)  As with goal #1, measuring what will have happened to the labor force, the capital stock, and aggregate GDP several years from now will be easy, but determining what difference the recovery package made will be difficult.
  4. Affect the mix of goods and services produced and how they are produced:  I see one of the goals of the recovery and reinvestment package as to intentionally change the allocation of resources in our economy–to encourage the production of goods and services, and the production methods, that improve the “public good.”  For example, policies that will directly purchase or indirectly encourage environmentally-sustainable technologies produce social benefits that exceed the private benefits to individual households or businesses.  The steering of our society’s resources toward these socially-beneficial activities thus can only be done by government and by definition (of an “externality” or a “public good”) would not otherwise be done by the private sector on its own.  A more adequate provision of these public goods that we have up to now underprovided (if that is our current judgment) necessarily implies a bigger government (as a share of our economy).  As with goal #2, the improvement in social welfare that would accrue is not something that is quantified in the traditional economic measure of aggregate GDP.

So the irony is that among these diverse goals that the policies in the economic recovery package are intended to address, those that are most likely to be achieved (#2 assistance and #4 increased public goods) are potential successes that will be the hardest to quantify.  And the goals that will be easiest to quantify through traditional economic measures (#1 short-term economic activity or “stimulus” and #3 longer-term economic growth) are still the hardest to evaluate in terms of policy effectiveness–and will be hard to evaluate even in hindsight.

In any case, I don’t personally see how the traditionally-favored, 8-years-failed, deficit-financed tax cuts of the Republicans (see today’s Washington Post story by Michael Shear and Paul Kane) do well on any of these goals.  Yet the murkiness of policy evaluation in terms of tax cuts and short-term and longer-term economic goals means we’re sure to be hearing “I told you so” from the Republicans for years to come, no matter what.

4 Responses to “Will It Work? That’s a Tough Question.”

  1. comment number 1 by: e-veblen

    Lot’s of overlap between your categories 1 and 2: The social safety net spending is, as you point out, indirect in its impact on domestic production (GDP)–however, this type of spending typically will be consumed in its entirety and become GDP quickly. While the assistance does go to consumers (and is technically as indirect as a middle-class tax cut), those consumers have very little choice but to spend as quickly as possible. That appeared to be happening in studies of last year’s refundable rebates as well.

  2. comment number 2 by: CDB

    The more easily quantified, the easier it would have been passed. For credit to be taken.

    So, the next step is to figure out how to get Republicans to read!

  3. comment number 3 by: Stephen

    Trivial comment, here, but Diane, I know you must have enjoyed as much as I the fact that the company featured in yesterday’s bill signing ceremony is Namaste Solar. :) The company’s Website offers this definition of namaste, which is quite appropriate in our current situation: “[Sanskrit] Greeting of great respect, celebrating the interdependence of all living things.” Um, Amen!

  4. comment number 4 by: economistmom

    I DID love that the company featured was “Namaste Solar”! I say “Namaste” at the end of each of the yoga classes I teach. My translation has always been “the light in me honors the light in you.”