Why Obama’s Plan is Likely to Fail: Obama, a poor student of Keynesian Economics

Tuesday, February 24, 2009

Economics is a fickle social study. For every Nobel Prize-winning theoretical principle, there is a Nobel Prize for the exact opposite theoretical principle. That being said, one should really think of economists as weathermen and not financial physicians. Since many of you may not be fully aware of the major schools of economic thought, I feel it is my job to provide at least some anecdotal explanation for Classical and Keynesian Economics.

Trying to lay out an exact account of each school of thought would be like trying to explain all the denominations in the Christian Church. With that in mind, my explanations are allusions at best. Classical economics is based primarily on the philosophy that people will appropriate their money in the most efficient manner. People are rational beings, thereby knowing all that is going on in the market and always seek to maximize their wealth. Sound contrived? Keynesian thought is based on psychology, the creation of money, and the belief that in economic downturn we are in trouble in the long run no matter what we do- so we might as well gamble in the short term. Psychologically, businesses and individuals base their investment or purchases on a particular percentage of their income. If you budget, that is the level of consumption you will make. If you always spend all your money, once again your consumption is fixed. The consumption of money portion goes like this: the more money that is made available to people, the more consumption and investment will occur. Government spending has what is called a multiplier effect. This means that money is given to one party, who spends it with a second party, who spends it with a third party and so on, creating a snowball effect. Finally, the outlook (downturn) portion basically states this; we’re in economic crisis now and it needs to be fought to deter long term damage, therefore we can spend dramatically, and if we fail we were doomed anyways. Please note: in any government spending, the result in the long term is inflation at best. For this reason, time frame is important to government spending. The idea is to turn things around before inflation occurs.

Ok, the boring part is out of the way. The problem with Obama’s plan is that it is an extreme gamble, and (in my opinion) a poor implementation of Keynesian Economics. Now, there was a lot in this bill- some of it is more promising than the rest. I’m going to cover three of Obama’s most vaunted projects in the bill.

  1. $400 to $800 given back to the American people. The problem with this idea is the way in which Obama is implementing the plan. By giving everyone $13 per paycheck, the increase will not realistically change your consumption. In fact, if you are not spending all your money, you probably won’t spend any of it. I for one am going to increase my 401k contribution (which is evil, because it works against the stimulus. I am not a very good American)
  2. Giving money to the states for “shovel ready” infrastructure. The plans may be already on a list, but that does not mean that it will be spent immediately. The bureaucracy most likely to spend these funds will be local county governments. Therefore, the federal government must dole out and apportion the funds to the states that must dole out and apportion to the local governments who must dole out and apportion to the companies doing the work, over the course of the project. Part of this project requires bidding from the companies, which takes time. Payments will be made over the course of the project, which may be completed over years. As stated before, time orientation is important and many critics of government economic policy is that it takes too long to come to the rescue. Now Obama may have helped pass the bill in record time, but he’s picked one of the slowest implementation processes. Additionally, this idea has very high and wasteful implementation costs. Panels in Washington need to work on the right amount to go to the states, the states need to work out the right amount to the counties and supervise its spending and counties need to turn the initiatives into contracts and supervise the construction progress. Very slow and very wasteful.
  3. Influx of funds to green technology. This may be a good idea in and of itself, but it simply is poor stimulus. Green energy may indeed be the future of energy altogether. However, companies do not have the distribution, experience or economies of scale to quickly implement this money. Wind farms often require government approval and environmental impact studies. These farms often find resistance from nearby homeowners. Both solar and wind power require large manufacturing facilities (that cause a lot of carbon, I might add!) to manufacture vehicles for these energies. Although there is a growing labor force, it would take time for a competent green energy labor force to be trained to satisfy the needs of a boom. Even if a boom started tomorrow, these companies would need time to meet demand. A result, the funds will bottle neck.

Could the Obama stimulus work? Of course it is possible. Obama is right in that spending is stimulus. The trouble is that not all spending is equal. In fact, I will go out on the line and tell you what I believe he should have done.

  1. Suspend payroll taxes for individuals and companies. The only thing really needed to administrate is the stroke of a pen, so it is low in wasteful administration costs. It would give people a significant amount in their paycheck (Way more than $13) and since half payroll taxes are paid by the worker and half by the company it reduces the cost for companies to hire labor. It’s even better for small business sole proprietors who bear the full costs. The truth is that labor is the easiest cost for companies to control and therefore is the first thing that goes when the going is tough. I shouldn’t need to give examples to prove this point. Finally, this would include every paycheck for the year as opposed to a single one time influx.
  2. Many people are going to hate me for this one, but we should lower corporate income taxes. I know everyone thinks that corporate profits are the devil. If you believe this, you are misinformed. Perhaps my next note will be on why corporate profit is good for everyone. I digress; there is an opportunity that is being missed with this entire global economic crisis. In our narcissistic American minds, our economy rises and falls by our own consumption. However, in today’s global economy, this is only partially responsible for economic growth. One reality that most people do not think of is that economies are competing for investment dollars. For a long time, the US has been able to attract foreign investment despite high tax rates on return. This truth has been waning as China and India grow. We have an opportunity to capitalize on the poor world economy and offer high investment returns for foreign investment by lowering corporate tax rates. Offer a higher rate of return through less taxes and foreign investment will greatly increase.

So there it is in a nutshell. Obama’s spending qualifies as government stimulus, but is weak when it comes to true stimulus. I believe the “everything and the kitchen sink” approach that Obama took also leaves more of a chance that part of the stimulus will fail, increasing the chance that the stimulus will not be large enough, thereby causing any stimulus that is working to be insufficient. I may be wrong, but it looks like the investors agree with me. The stock market plunged the day the bill was signed.

2 comments

The Law said...

I've heard this argument a lot. And I am no economist by any means (and I kno wyou are!) so my response of course needs to be taken with a grain of salt.

I see where you are coming from for sure, and your solution seems to be the text book solution on how to get out of this mess. (by which I mean your solution should work under normal paramneters, not diminishing your opionion at all!) However, the real-time, on the ground, in the trenches situation seems to indicate that plan just wouldnt work. I live in the state that has the 3rd highest unemployment rate, the state is bankrupt, and I have seen first hand that businesses dont have enough moeny to make payroll (which is why I get paid when he can pay me =[ ). Payroll taxes are no good when you don't have a job, which is the case of nearly 1 in 10 people in my state. #2 seems to refer to trickle down economics, which in principle would work well. But as we've seen, the CEOs of big business instead spend money on $50 million dollar jets, corporate jets, and lavish renovations. Money is hoarded and redistributed upwards to the wealthiest few and doesn't get reinvested as it should back into small business. While there should be *some* tax cuts, it should not comprise the larger portion of the bill.

my $0.02 from an avid reader of newspapers, but no book knowledge whatsoever on the subject =)

February 25, 2009 at 6:15 AM

You are a brave soul my friend :) and I greatly appreciate your opinion here and I want to add something that is missing from my post. I am for job creation, even if it is not in the form of tax cuts. My problem is a lot of the stimulus is channeled into streams that are long term and will not get us out of the situation, because stimulous needs to dramatically change peoples behavoir in the short term. I only covered the president's three biggest areas and there is some stuff in this bill I believe will stimulate jobs. I seriously accept any alternatives if you have them.

I believe you should see things from two view points. First, I believe their is a problem with executive compensation. However (and there are a few exceptions ...big oil... cough, corporations and companies are not evil. You mentioned your employer, if he was making more of a profit, is it likely you'd have regular work? Not knowing his line of business, he's probably taxed at least 30% of his profits which could be used to reinvest. Perhaps in more employees for expansion.

This leads me to the other view point. You need to look from the perspective of a business owner. This is important as it is people running businesses that will ultimately determine if they are going to hire. When times are tough, companies look to cut. If they want to stay in business they will need to keep buying supplies to make product and they are not going to be able to just get a smaller factory or sell off half their equipment, because doing so takes a long time and they have a problem now. So they look to cut something else and it is almost always labor. The beauty of an actual repeal of payroll taxes (of which Obama cut only a very little and only for employees) means about $200 more a month to your average employees and make labor 9% cheaper. That is a huge reduction and you would see companies not need to cut as much. Also, this tax cut only comes when you have labor, they couldn't just fire and pocket the money. It's a direct reward to the company for employment. Also, payroll taxes are already set up so that the rich won't benefit. Once your income is $95,000 you do not pay any additional payroll taxes. Therefore, Mr. CEO will not be getting any more money back than someone at $95,000. It would result in Mr. CEO getting about $175 per week. Myself and my wife combined would get back almost as much.

I can completely understand anybody's objection to corporate tax cuts. The truth is, stimulus needs to change mentalities to get people to spend and get people to invest quickly. I think that payroll taxes is very dramatic and would get people to consume more (it's like getting a raise at work). I think cutting corporate income taxes would help a dramamtic flow of investment. However, the stimulus as it is killed corporate investment. Everytime Obama speaks on the economy the stocks tumble. This is an indication that investors (many of whom have a very good idea about the economy) do not feel comfortable with Obama at the helm. Why should they when he has either been vague on his plans or introduced plans that have nothing to do with helping the economy. Consumption and consumer confidence has plummeted due to Obama's doom and gloom campaign to push the stimulus. Honestly, this bill was poorly implemented and it will cost our economy dearly.

February 25, 2009 at 11:44 AM

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