Fiscal Stimulus: Target The Oversupplies

Adding a bit to Krugman’s latest.

Think about it: what would the true costs be of repairing our roads? It wouldn’t divert capital from other investments — capital has no place to go, and markets are practically begging the federal government to borrow funds and put it to work.

 

Conservatives and Libertarians and Austrians want to ignore the fact that government debt is amortized, and fall back on Say’s “Law,” saying that deficit stimulus doesn’t work because the market adjusts spending based on future taxes. (The response is that no one has the credit score of the US government at the moment, so when the US government borrows, it borrows at a rate that is lower than anyone else currently gets, so there is no spending the free market can offer that costs less over time).

But some will object on the grounds that government spending causes over-investment – causes market resources to be devoted to something that only the government is interested in buying, and once the spending on that terminates, the market adjustment will produce another shock. Also, a big expenditure by the government will surely lead to opportunistic price-setting, forcing the government to overpay for whatever it decides to buy during the stimulus. These two inter-related points are what I really want to address.

If you’re going to engage in stimulus, you want to focus on goods that are oversupplied. There’s an oversupply of capital into government bonds, so we’re good on deficit spending. There’s an oversupply of construction labor, so we’re good there, too. The only real limits to infrastructure spending are the fact that a lot of construction workers and companies have either gone under or started looking elsewhere. It would have been better to do this five years ago, of course.

But the real key here is to see that, for instance, stimulus is a bad idea if, say, you focus it on purchasing services from physicians. The supply of physicians is limited and not elastic (because new ones take about 8 years to train up, and there’s a very small supply of physicians that gave up medicine to work elsewhere in the economy). Thus, supply-vs-demand pricing tells you that a large, sudden increase in physician-services spending by the government will cause a huge shortfall in the supply of physician services – leading to a huge increase in prices, and, TA-DA, inflation. This is the inflation people like Peter Schiff and Ron Paul have been prognosticating about continually, claiming it’s going to hit us any day now. But if you focus government spending on parts of the market that are oversupplied, you don’t get inflation.

This doesn’t merely work during recessions, nor must it be limited to infrastructure. What is the preferred teacher to student ratio? State and local governments laid off large numbers of teachers and to the degree they’ve begun to replace those jobs, they’ve been using teaching aids much more than actual teachers – because teaching aid jobs allow districts to pay people less for a very similar job. All of this means we have an oversupply of people qualified to teach, an oversupply of students, and a ripe opportunity for “stimulus” spending on restoring the number of teachers to the preferred teacher-to-student ratio. (Personally, I think the teacher-to-student ratio is a poor way of measuring education quality, but we’ve underfunded schools so much and laid off so many educators over the past 5 years that the ratio is good enough for speaking about where we have a “buying” opportunity).

Once we get through this recession, nothing will have really changed on the general principle that it is a perfectly valid use of government spending to weigh the borrowing costs of government bonds against the price at which government spending can “stimulate” market sectors that are essentially “under-priced.” Defense spending is one such area – not that we “need” to spend more on defense, but rather, in our society, the private sector doesn’t spend much on national defense. If it did, we wouldn’t need a Federally-financed military (as far as funding is concerned – the needs of the power hierarchy are another thing). Since we happen to live in a culture that sees fit to offload this investment (the wisdom of the investment varies depending on the international climate), it is appropriate for the government to execute what amounts to a military-goods market stimulus – even when we’re not in recession.

Many Conservatives critique calls for stimulus during a recession, saying that to liberals, the solution is always stimulus – not just during a liquidity-trap – but even during the mildest recession. They are partly correct – but they’ve missed the general rule: A government should always look at its borrowing costs and its “market opportunities” – and spend if and when a “buying” opportunity arises. This is a subjective process in many ways – president George Bush saw a military “buying” opportunity in Iraq that others didn’t agree with. But when federal borrowing costs reach something close to 0% interest, infrastructure projects that have a 50-100 year payback start to become no-brainers.

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About stormculture

In pursuit of reality.
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