Wednesday, August 31, 2011

The "long" fiscal stimulus - a belated recognition of infrastructure spending?

Prof Tyler Cowen has a strange post. He points to the inadequacy of short-term stimulus spending, however large, to tide over deleveraging balance sheet recessions. He is therefore surprised that

"For all the talk of a 'large stimulus', you don’t hear much about a 'longer stimulus'."

He has this concern about short-term pump priming, whatever its size,

"The problem with a 'too small' stimulus is that you get an initial economic boost, but when the stimulus expires the economy slumps back down, as indeed happened in mid 2011. Ideally a stimulus employs some idle labor, stops it from depreciating, and tides those workers over until they can look for other jobs in fundamentally better economic conditions... If conditions are not improving soon, the ability of the stimulus to 'buy time' for those workers isn’t worth much... We end up having spent a lot of money to postpone our adjustment problems, rather than achieving takeoff. Deleveraging recessions last a long time, as shown by Rogoff and Reinhart. The need for continuing deleveraging implies that even a stimulus twice the size of ARRA won’t turn the tide."

In the circumstances, his suggestion,

"In those cases a well-designed stimulus program should not be so 'timely'. For a given presented expected value sum spent on stimulus, it is better to spread it out across the years. It is better to help a smaller set of workers for five years (or however many years it takes for most of the deleveraging to end), after which they are reemployable, than to temporarily boost a larger number of workers for two years, and then leave them back in the dust because deleveraging is still going on."

Here we go! There appears to be, to put it very charitably, an element of selective amnesia in Tyler's post here. This is effectively an admission of ideological failure (or, is it an error of judgement?) and an advocacy for focusing stimulus spending on creating durable public infrastructure assets atleast now.

In some sense, it is a classic case of the two-handed economist at work, albeit with a time lag in the action of the two hands. The one hand which had considered, debated and opposed the same when the ARRA was being formulated now appears to have changed track and embraced infrastructure spending when the earlier assumptions were proved wrong.

As early as late 2008, when the ARRA was being conceptualized, there was an intense and often acrimonious debate about the nature of the stimulus. Conservatives, who even then opposed any fiscal action, were willing to go only as far as tax cuts. They had opposed it on the grounds that there was no shelf of "shovel ready" infrastructure projects and that such spending takes time before its shows any stimulus effect on the economy. Marginal Revolution itself had directly posted and linked to several such views. In contrast, liberal economists like Paul Krugman, Mark Thoma and Brad DeLong felt that the recession was likely to persist for long and therefore preferred direct spending in infrastructure assets.

From hindsight, even the most conservative of economists would admit that the best course of fiscal policy action in late 2008 would have been to spend money on public infrastructure creation. The ultra-low interest rates, now certain to persist well into 2013 and atleast for a couple of years beyond that, would have provided unbelievably cheap financing for atleast 7-8 years. If in 2006, Congressmen and academics had been offered the prospect of accessing interest free loan for 8-10 years to repair America's battered infrastructure, many of them would have readily grabbed that opportunity. In fact, even the China-bashing Americans would have derived some vicarious pleasure from the realization that China was subsidizing America's infrastructure creation by offering virtually interest free loans!

In fact, Tyler's invocation of Reinhart-Rogoff now to fortify his argument about the pernicious nature of deleveraging recessions, appears to be a case of "what is sauce for the goose (is not) sauce for the gander"! Interestingly, Messers Krugman and Co had then invoked precisely the same duo to base their claim for infrastructure spending based stimulus. They had argued, based on the substantial body of empirical evidence presented by Reinhart-Rogoff about the average lengths of banking crisis induced recessions, that the Great Recession was likely to be a long drawn out one and therefore there was enough time for infrastructure spending to be effective.

The ideal course of action in late 2008 would have been to adopt a two-pronged approach, one which many of the aforementioned liberal/Keynesian economists did advocate, involving long-term stimulus on infrastructure creation and automatic stabilizers like unemployment insurance and food stamps to cushion the worst hit by the recession. Any tax cuts and other stimulus spending would have been an additional bonus.

I am inclined to believe that the impact of such spending on the economy as a whole would have been positive in many dimensions. Apart from the fact that it would have repaired or replaced the country's battered infrastructure, it would also have generated a significant multiplier on the economy on many fronts. It would have brought to work idle resources, encouraged businesses to not postpone investments, spurred market confidence (yes, the "confidence fairy"!) in the long-term health of the country, and so on. Given the fact that these investments were in any case necessary, one would also have to add the opportunity cost benefits of the ultra-low interest rates to calculate the multiplier.

In view of all the aforementioned, the final paragraph to Tyler's post is a sad commentary of the dark age of macroeconomics,

"Oddly, there is not much discussion about the length of fiscal stimulus. But there should be."

PS: I just did not have to energy to mine the numerous links in MR, and Krugman, Thoma and DeLong's blogs that contain the specific material from 2008-09 that I have alluded to in the post. I guess I am lazy! Anyways, interested readers could do so from here and here.

1 comment:

KP said...

Dear Gulzar,

Philip Pilkington has been trying to explain this phenomenon in his blog -the search of profits and disequilibrium.

like to have your comments on this post.

Does this imply that that governments have to necessarily think of smarter means of redistribution - to actively keep growth rates high. And this policy is not necessarily dependent on earnings from trade.

For India, does this imply that years of the "hindu rate of growth" are a product of

- insignificant availability of quality public goods in health and education, primarily ( not funding / or provisioning but effective availability)

- poor return on capital invested (corruption / delivery systems)

and currently,

- A reliance on trade led growth as the dominant policy ( reform, FDI etc) and not enough courage to invest internally (deficit financing)

like to have your opinions.