The Theory:
The question of proper economic stimulus is one of the areas where economists disagree. It should speak to the complexity of the economic dynamics that thousands of PHDs study an issue and yet fail to come to consensus. The two schools of thought I'll talk about are Keynes and Hayek. For a fun summary of each schools' thoughts, watch this youtube rap (yes, I said rap… about economics):
In short, Keynes argues that once circular flow is established, market participants will have the resources to enact the necessary market changes in a timely manner. As a result, the government should focus on spending money on just about anything to restart circular flow. Hayek disagrees.
Hayek argues that people choose to stop spending and save because demand patterns change. As a result, no matter how much money you spend, people still don't demand the existing product mix. When the government spends excessively, it distorts demand for a particular market and generates inflation. Hayek argues that it's actually our actions, particularly low interest rates and borrowing, during the expansion that creates the recession.
Hayek's arguments make a lot of sense. If millions of people and billions of dollars of capital are employed making something that either isn't demanded or is demanded at a much lower rate, those people and that capital need to move out of the industry. Imagine if 10% of our economy had been involved in the production of typewriters when computers started hitting the markets. Suddenly, people no longer demand typewriters. No amount of government spending could keep people employed making typewriters.
The question is how does this affect stimulus plans? One of the biggest complaints with Hayek's philosophy (and conversely the biggest draws to Keynes) is that it requires followers to sit and do nothing, but that isn't exactly true. Hayek merely warns about creating inflation and distorting markets.
Why current stimulus plans don't work:
Will a pure Keynesian approach work? Yes. However, if your goal is job creation, it won't work well. Stop and think about where the money from the stimulus plans go: building roads and bridges, environmental research, high speed rail systems, low-income housing, etc. Not one of these creates initial jobs, and most of the spending is on things that were not in demand before the recession. What this means is that the effects of the stimulus will be slow and obscenely expensive.
Think about the resource structure created when the government pours money into road construction. People are hired to build roads, capital is purchased to build roads, and the roads get built. Now what? People had jobs, but the private industry isn't buying new roads. If the government doesn't keep spending money, these created "jobs" will cease to exist. Therefore, government spending outside of areas in demand by private markets can only create secondary jobs (Road construction worker got money from job, now spends it, giving someone else a job).
The New Plan:
Any company that employs fewer than 50 people may take up to a $25,000 tax credit for expanding their workforce by 1 person and paying them at least $50,000.
What it does:
Puts small businesses in a position to quickly adapt to market conditions and decreases the risk of trying to expand into new opportunities.
Why it works:
Current stimulus plans attempt to "stimulate the economy" or "increase investment", but the big picture is that all of these efforts are attempts to get people employed. In fact, it's the unemployment that makes recessions so bad. Very few people care about reduced output or exchange rate implications. Why then, shouldn't our stimulus focus on the very thing we're trying to fix?
Ask an entrepreneur how much money it would take for them to hire someone new at $50,000, $60,000, or $80,000 a year. The answers you get will fluctuate widely, but not one of them will exceed the salary paid. How then is it that the current stimulus plan is estimated to have cost over $250,000 per job? Mismanagement and ideology.
Does this plan distort markets? Yes. But it distorts the labor market, causing wages to rise. It distorts the market for new business, which brings new products and innovations to the economy. Further, since the plan is a tax credit, if it doesn't work, it costs us nothing. Finally, when the credit goes away in a year, the products being built and services being offered are still the ones in demand by the market, since the market has been the customer all along. Sure the profitability goes down without the credit, but the business still has a chance to be profitable.
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