THE BLOG

Stimulus Plans Don't Work

Feb 19, 2009 | Updated May 25, 2011

The United States and the world economy have been declining for the last year, with rising unemployment rates. It is widely believed the government must "do something." Many call for a "stimulus program", and President Obama just announced a $800 billion stimulus plan. Already staring at a $1.2 trillion dollar deficit for the year, about 8% of the entire U.S. economy, the resulting deficit would be twice as large as anything we have seen since World War II.

So it begs the question, what does "stimulus" mean and what does it really do?

Economist John Maynard Keynes posited a theory that the economy can be boosted if the government borrows money and spends it, circulating it through the economy and thus stimulating it back to life.

But this theory has a conspicuous logical fallacy. It ignores the fact government can't put money into the economy without first taking money out of the economy. Because the government needs to borrow the money it uses for the stimulus plan, it follows that rather than boosting national income, it merely redistributes it. This is analogous to taking water from the deep end of a pool and putting it into the shallow end. It creates busy work and the illusion of action, but actually produces nothing while sapping the economy of resources that would otherwise be used advantageously.

Furthermore, not just theory but the evidence also shows that Keynesianism does not work. Both Hoover and FDR increased spending and ran large deficits, yet the economy did not get better for more than a decade. In fact, in May 1939, Treasury Secretary Henry Morgenthau testified:

"We are spending more money than we have ever spent before, and it does not work. ... We have never made good on our promises. ...after eight years of this administration we have just as much unemployment as when we started ... and an enormous debt, to boot."

The Gerald Ford and George W. Bush administrations also tried ratcheting up government spending, to no avail. Similar methods were also tried in Japan during the 1990s, and caused Japan's lost decade.

Economic growth occurs when there is an increase in national income, not a redistribution of it. That is why lower marginal tax rates are the best strategy to achieve growth. Ronald Reagan cut taxes by 25%, and triggered the economic success of the '80's. The Kennedy tax cuts of the '60's were highly successful. Calvin Coolidge cut tax rates from almost 70% to 25%, and it created the prosperity of the '20's.

So if our government has money to spend, it is far better to suspend all personal income tax for six months. That will cost about $700 billion, less than Obama's stimulus plan, and create an unprecedented flurry of economic activity. And people will be spending their own money, rather than government bureaucrats doing it for them. That is more appropriate as a matter of principle, and more effective as a practical matter, as the money will surely be put to better use.

Ask yourself: If spending $800 billion would jump start the economy, why not spend ten times as much, and really get the economy going? It is obvious the logic is severely challenged here.

And ponder this: if you assume that about 100 people in Washington are going to have meaningful input in the decision on how to spend this enormous stimulus of $800 billion, then on average each person is responsible for spending about $8 billion of our money. Can anyone in government spend that much money, $8,000 from every US household, more wisely than the average American would spend it? I simply do not believe that, and I also reject the morally dubious concept of taking people's money and spending it on their behalf, supposedly for their own good.

It makes sense to rely on private enterprise and not on government as the engine of growth. The US always did best when the government shrank, and worst when it grew. If big government was the way to economic prosperity, than France should have been a financial powerhouse, and Hong Kong should have been a basket case. But of course it is exactly the opposite.

Spending is the problem that caused this crisis in the first place. We cannot fix the problem using more of its root cause. Other than that, the President unfortunately cannot do much, and shouldn't work himself into an unnecessary frenzy. As Michael Gerson eloquently put it in one of his Washington Post columns, "American presidents have few levers long enough to shift a continental economy. During an economic winter, they shovel the snow -- and then take credit for the spring."

Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.