Costs of the stimulus

Most criticism of the fiscal package have centered on its impotence: consumption smoothing agents will make it moot or it’s effects won’t be seen in time to make a difference. So we’ve all been talking about multipliers. There’s a possibility, though, that the stimulus actually does harm:

Stimulus plans that bailout the financial and auto sector will influence innovation and reallocation. Reallocation may particularly suffer if the stimulus plans lock in factors in low-productivity sectors and activities. Market signals suggest that labour and capital should be reallocated away from, for example, the Detroit Big Three and highly skilled labour should be reallocated away from the financial industry towards more innovative sectors. Halted reallocation will also mean halted innovation.

Not only are we saddling future generations with debt, but we may be making them poorer than they might otherwise have been. Economic efficiency is generated through sectoral reallocation and efficiency creates growth. Even small reductions in efficiency have huge effects in the long run. For example, suppose the fiscal stimulus solidifies the expectation that big firms are too big to fail. This will cause too many resources to be allocated to big, established firms where innovation isn’t as hectic. Even if this has a small growth effect — let’s say it reduces growth rates by 0.3% — it only takes a generation for this swamp out the size of the additional debt created by the stimulus package.

As we saw in the global warming debates, this point is almost impossible to get across. Future growth is particularly intangible for most people.

6 thoughts on “Costs of the stimulus”

  1. I watched a movie a couple of weeks ago. A couple of local guides are driving a tourist through the Ukranian countryside. They detour down a dirt road, into thick woods. They pass the overgrown, abandoned hulk of a solitary apartment block, out in the middle of nowhere.

    Tourist: “What happened here?”
    Guide: “Soviets.”

    I don’t know how you got to global warming from that. Having your country’s water supply crash will put a big dent in your future growth rate too. This point is almost impossible to get across.

  2. Yes, for some reason its easy to imagine that potential calamities far in the future will be bad for the people living then. Its much harder to imagine, it seems, that even small actions today can compound to have huge impacts on the wealth of future generations.

    Also, there tends to be an asymmetry of concern. We care that people’s current wealth doesn’t get destroyed (by environmental disaster or economic downturn), but we don’t seem to care as much about that same wealth not being allowed to accumulate. To me, we’re talking about two sides of the same coin: high standard of living is reduced or its not allowed to be created in the first place.

  3. Well… look at how hard people fight for education, even to the point where they want to sacrifice someone’s prime labor years sitting in a classroom. Think of all of those 19-year-olds wasting away in English 101 when they could be hauling timber or planting crops. It’s tougher to consider that keeping debt off of your credit card now can translate to the equivalent of higher pay in the future.

    I’m sure you’ve seen the experiments in micro where participants overwhelmingly prefer a small immediate reward over a larger deferred reward. Surely “keep your shit now” overrides “probably have more shit later?”

    Don’t get me wrong: the idea of firing up Detroit to pump a fleet of new SUVs straight into the scrapyard bugs the hell out of me too. I’m not wild about making all kinds of fiscal and environmental sacrifices to satisfy the romantic wishes of a select few who want to re-enact the rust belt’s glory days.

  4. My complaint isn’t about how forward-looking people are. For example, I mentioned people don’t seem to have a problem imagining the consequences of a large calamity far in the future. That’s me admitting people are forward-looking.

    My complaint is that they’re only forward-looking sometimes…

  5. Maybe growth proponents just need better marketing. And a celebrity spokesperson. An “Embiggen the Pie” campaign.

  6. Late to the game, but to the main point of the original post: Isn’t this glaringly obvious? After we bail out Detroit, we’re going to start recruiting mediocre baseball players to major-league teams just so they can have a paycheck. Viability of the team be damned.

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