The Heritage Foundation - Leadership for America

Just like Keynesian economics, electroshock therapy was first introduced in the 1930s and then gained widespread use in the 1940s. Now President-elect Barack Obama “anxious to jolt the economy back to life” is considering a federal stimulus package that could reach a whopping $1 trillion. Now that is a shocking number.

Problem is, there is just no academic or real world evidence to suggest such a massive ’shock’ would be healthy for the U.S. economy. In the 1990s, Japan rapidly increased government spending in an effort to recover from its economic downturn, but this led to slow groth, low industrial production, and a decline in the overall standard of living. Studies by the Congressional Research Service, the Government Accountability Office, and the Congressional Budget Office have concluded that the impact of transportation spending on jobs would be much less than anticipated—in fact highway construction could even have a negative impact on the economy.

Spending-stimulus advocates believe the government can create economic growth by “injecting” new money into the economy, increasing demand and, therefore, production. This raises the obvious question: Where does the gov­ernment acquire the money it pumps into the econ­omy? Congress does not have a vault of money waiting to be distributed. The Federal Reserve could print a bunch of new money, but that would send inflation soaring and make us no better than a banana republic. Therefore, every dollar Congress “injects” into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistrib­uted from one group of people to another.

Spending advocates typically respond that redistributing money from “savers” to “spend­ers” will lead to additional spending. That assumes savers store their savings in their mattresses or elsewhere outside the economy. In reality, nearly all Americans either invest their savings by purchasing financial assets such as stocks and bonds (which finances business investment), or by purchasing non-financial assets such as real estate, or they deposit it in banks (which quickly lend it to others to spend). The money is used regardless of whether people spend or save. The only way government redistribution can lead to more growth is if the government is better at efficiently allocating resources than the market otherwise would have been. And here governments have a historically terrible track record:

• Public Finance Review reported that “higher total government expenditure, no matter how financed, is associated with a lower growth rate of real per capita gross state product.”
• The Quarterly Journal of Economics reported that “the ratio of real government consumption expenditure to real GDP had a negative associa­tion with growth and investment … growth is inversely related to the share of government consumption in GDP, but insignificantly related to the share of public investment.”
• Public Choice reported that “a one percent in­crease in government spending as a percent of GDP (from, say, 30 to 31%) would raise the un­employment rate by approximately .36 of one percent (from, say, 8 to 8.36 percent).”

Massive spending hikes in the 1930s, 1960s and 1970s all failed to increase economic growth rates. Yet in the 1980s and 1990s — when the federal government shrank by one-fifth as a percentage of gross domestic product (GDP) — the U.S. economy enjoyed its great­est expansion to date. Heritage senior policy analyst Brian Riedl concludes:

Rather than redistributing money, lawmakers should focus on improving long-term productivity. This means reducing marginal tax rates to encourage working, saving, and investing. It also means promoting free trade, cutting unnecessary red tape, and streamlining wasteful spending that all weaken the private sector’s ability to generate income and create wealth. Finally, it means strengthening edu­cation — not just throwing money at it. Addressing long-term growth and productivity is more chal­lenging than waving the magic wand of short-term “stimulus” spending—but a more productive economy will be better prepared to handle future economic downturns.