In my last post, I talked about why stimulus programs have such a high tendency to fail. I explained the difference between the country's incentive and the politicians' incentives. First before we begin; I am only talking about stimulus programs, not bailouts like TARP. I will deal with TARP in a later post, but for now it's not my focus.
In this post, let's get to a more important issue: Is there any chance a stimulus program can be efficient? Let's say we got the best politicians in the world, they are super-patriotic and want nothing but to help their country prosper - wouldn't it work then?
In a word; No. The problem with stimulus programs is much wider than just political egoism (which I talked about in my last post).
Let's look at two different (hypothetical) stimulus programs:
1) The housing market has crashed, developers and construction companies are suffering all over the country. 100 000's of houses (some recently finished, some just started) lays abandoned all over the land, with no buyers in sight. Thousands of construction workers are laid off every day, unemployment in the sector skyrockets. The government understands that if nothing is done, it's just a matter of time before the rest of the economy as well as the financial system is hit, so it decides to buy up all these houses that no-one wants to buy, and also send every household with negative equity homes a cheque, big enough to solve their problems.
This is an efficient stimulus - it targets the source of the pain, it solves the root of the problem so to speak. The property market was the problem, so of course the property market is the market where you should stimulate.
Of course, there's a catch: Moral hazard. If you save the very people who created the crisis, you increase the risk that it happens again. You create an incentive to fail when you allow them to escape the consequences they should suffer under the rules of capitalism. And since the government has to tax (not to mention borrow) in order to put together a stimulus package, you are taking from the innocent only to give to the guilty.
This kind of moral hazard can unstabilize and depress a market forever; investors don't want to invest if they know there's a great incentive for activities that will lead to financial crises.
So while in theory it's very efficient, as you can see, there's a huge catch. Let's move on.
2) The housing market has crashed, developers and construction companies are suffering all over the country. 100 000's of houses (some recently finished, some just started) lays abandoned all over the land, with no buyers in sight. Thousands of construction workers are laid off every day, unemployment in the sector skyrockets. The government understands that something has to be done to boost "aggregate demand". So they invest, but instead of concentrating their investments to one sector, they spread the investments around. They don't want to create a moral hazard, so instead of focusing on housing, they invest in everything from education, to research, to airports and everything else under the sun. They do relatively little to stop the housing crash, instead investing in the rest of the economy to keep the total demand in the economy at a constant level. In theory not an all too bad idea, the problem is that this is slower (deciding exactly where to spend the money is bound to take some time) than just buying every empty house there is on the market and giving every troubled homeowner a cheque. And, since the housing crash continues in the background, consumer confidence will continue to fall as the black headlines continue to come. Also, when all the special interest groups hear that Washington plans to spend money on everything, they will rush to DC to convince (bribe?) every congressman and senator there is that they deserve a piece of the cake. Heavy corruption is bound to happen, and the incentives for politicians to spend the money inefficiently (like I wrote about in the last post) will be enormous.
One creates moral hazard, perverse incentives and an unstable market which will forever rely on and trust the government to save losers. The other leads to corruption and is slow. And since the thing with a stimulus program is that it should speed up a recovery and give the economy a vitamin injection, that would kind of ruin the point.
There is no efficient stimulus program.
Thanks for reading,