The rising unemployment rate has alarmed politically motivated liberal economists, such as Princeton professor Krugman, who now call for another massive fiscal stimulus. These economists, including Krugman, are in the grip of an erroneous political-economic paradigm. They believe that putting more money into the pockets of consumers, by one means or the other, will stimulate consumers to buy, leading to increase in demand, leading to increased production. Increased production would lead companies to hire, thereby reducing the unemployment rate and stoking prosperity. Alas, nearly all their assumptions are wrong. The links in the chain are broken. American companies don't need to hire to increase production. Most of the companies that do the producing of tangible goods are not here in the states; increasing production would occur in other countries, such as China, helping lower their unemployment rate and increasing their exports, but not helping the US. Consumers will not spend most of the money put into their pockets, because they know that once it is spent there would be no more coming, so they must save most of it. Most of the stimulus money from the February 2009 act was supposed to fund "shovel ready" projects under state control; but, in fact, in governmental bureaucracies, no project is ever shovel ready. Only 10% of the funds have been expended. The main effect of the so-called stimulus has been to help states maintain their state employee rolls--teachers, bureaucrats, highway departments, and so on. It hasn't reduced the unemployment rolls at all. These employees are not productive. Their activity does nothing to increase private employment. Putting money into a reform of the national health care system would have the similar effect. Health care is not directly productive and does not directly return economic growth. Further stimulus of the sort we have already seen would only dig our economic hole deeper.
The economic hole is being dug by erroneous assumptions also about funding. The money that the feds want to spend in stimulus are simply deficit dollars, i.e., printed paper money. Printed paper money represents loans to the federal government. Those loans have to be paid for and liberal economics has only two ways to pay for them--increased taxation or inflation. If the feds increase taxes then it takes real money away from consumers, reducing their purchasing power, reducing consumption, and making worse the economic recession we are in. If the feds don't increase taxes to pay back the loans, but instead just continue to issue deficit dollars, then they cause inflation. Inflation brings not only higher prices, but also higher interest rates. With prices, but not wages, going higher, consumers can purchase less, thereby decreasing consumption, thereby perpetuating the vicious cycle of liberal depression economics.
The only way to get out of the hole we are in is through invention and innovation of new products and their production by new or expanded companies engaged in producing tangible products here in the US. These companies will hire new employees, reducing unemployment, giving consumers a cycle of employment that will give them confidence to spend, and thereby generate prosperity. We need to base our economic thinking on development economics, to think of ourselves today as from the perspective of fifty years from now, as an under-developed debtor economy.
So the real question, the key to recovered prosperity, is this: how do we encourage technological innovation, investment in research and development, innovation in production techniques, and formation of new companies here in the US (without igniting an international trade war by legislating buy-America policies)? Put it differently, how do we reproduce something like the great industrial revolutions that gave us mass produced Bessemer method steel? The telephone? Alternating current electricity? 'The internal combustion engine? The moving assembly line? The radio and broadcast media? The computer? These great products were the basis of the infrastructure for a new economic level of production and consumption. If we want such a new level again, that's the sort of invention we need. This process is called, economic growth.
(Economic growth would increase the federal tax haul, even with greatly reduced tax rates on individuals and companies, so government programs could be funded from productive dollars rather than deficit dollars. Nearly everyone today accepts this notion; what we need to do is to conceptualize it from the point of view of the kind of technological-economic revolution we need, that is, from the depths of our need.)
Obama and the Democrats would say that their eco-green technologies will perform that role; so we should throw federal stimulus money at them. But those technologies can't. Here's why:
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First, the technologies are already developed and in the hands (i.e., patents, first producer advantage, control of foreign markets, etc.) of companies outside the US. Production of wind turbines, nuclear power, hybrid auto engines, etc., are already done and dominated by companies in the Netherlands, India, France, Japan, and so on. Without erecting barriers to trade or giving unfair subsidies to consumption of US products (both policies which would ignite trade wars), US start-ups are way behind the ball.
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Second, these technologies cannot in the short term of ten or twenty years create an economic revolution. No one believes that more a few percentage points of US energy production can come from such technologies in that time.
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Third, as much they would "free" us from foreign oil, they would injure the economies of Canada and Mexico, who are the two biggest foreign exporters of oil to us. As they are also our largest trading partners for exports (using dollars we pay them for their oil to buy products from us), hurting their economies would hurt our economy; therefore, such "oil independence" would be an economic net wash, with small gains in one area being erased by losses in other areas.
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Fourth, such technologies are not economic game-changers. They are simply new ways of doing old tasks. Since their justification is ultimately "health" and not efficiency, they do not increase productivity, do not earn productivity-dollars for the economy, and do not generate net savings that can be invested in other enterprises.
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Fifth, because they require a heavy level of regulation for implementation and to compel consumption (and because they don't generate efficiencies), they are net deficits for the productive economy. Economically, they're dead ends.
The only way--and it's the best way--to effect a technological revolution as the basis to a new economic level of production and consumption is by unencumbering private enterprise in the free market to invest, to produce, and to sell. Reduce taxation, reduce regulation, incentivize investment, incentivize motivation, free markets, end government monopolization and control of markets, end labor monopolies. Let individual inventors, investors, and producers figure out how best to make lots of money from something new. In the past 200 years, this technique has always worked, whereas government control of this process has always failed.
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See also my primer on the economic crisis.
Update. July 11, 2009. Larry Kudlow explains clearly why the tax and regulation increases planned by Obama and the Democrats will harm our economy.
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