Danger In Stimulus Plans

The fact that the world is undergoing a severe recession is not surprising. We have had many years of prosperity and, if not precisely inevitable, it is often the case that long periods of prosperity lead people to forget there are risks related to taking on debt and to lending too aggressively.

All bubbles burst, all rose-colored views of the world must one day see reality, and so we will have periods of economic contraction from time to time. This should never be taken lightly. People suffer, lose jobs, homes, and businesses, and there is much sadness in these trying times. People in developing countries — where the middle classes are newer and have not had as much time to build up equity — will often suffer the most.

As troubling as a recession is, the basis for the next cycle of prosperity is in the deleveraging of banking, household balance sheets, and commercial enterprises. That is why, inherently, governmental efforts to “stimulate the economy” are problematic. If the economy is depressed because people are rebuilding their balance sheets — paying off debt and avoiding expenditures — enticing people to borrow and spend will be problematic because that will delay the rebuilding of the family balance sheet. Equally, if financial institutions are not lending because credit-worthy deals are not crossing their plate, pushing banks to make loans to individuals and businesses that won’t be able to repay the money is just setting up a new bubble.

Besides, efforts to stimulate the economy typically fail. First, efforts to spend money typically take so long that by the time the “stimulus” is spent, the economy is already recovered and in danger of overheating. Second, rare indeed is the politician who can simply pay attention to the problem at hand. Typically, the politicians use the stimulus need as an excuse to fund pet projects and programs that have little, if any, stimulative effect. Finally, the stimulus is typically weak anyway, because any money spent has to come from somewhere. If it comes from taxes or borrowing, it’s money that can’t be used by people and businesses. So the stimulus is only stimulative to the extent the economic activity generated by the government expenditure of these funds exceeds what economic activity would have been generated had individuals and businesses been left to spend and invest the funds.

Stimulus or not, the truth is the economy has enormous recuperative power and within a year or two, if the government does nothing, the recovery will commence.

There is, however, a real danger that governments around the world could fall into a protectionist trap that could transform a recession into a worldwide depression.

In the proposed stimulus bill in the United States, there is a clause requiring that iron and steel used in the construction of projects paid for by the bill be produced only in the United States. Very quickly, that clause led a cacophony of other industries to lobby for more “buy American” provisions. The Senate Appropriations Committee added a clause that all “manufactured goods” purchased by the stimulus funds be manufactured in the United States. As of this writing, the bill was still in flux and the ultimate outcome uncertain. These American-only clauses are a disaster. First, they violate America’s obligations under all kinds of international agreements, from the World Trade Organization to the North American Free Trade Agreement to other regional free trade agreements. Second, the United States isn’t the only one with a stimulus package. China is going to have its own, for example, and it is probably in excess of half a trillion dollars. One can count on the United States being excluded from these types of programs if the United States excludes others.

The European steel industry has said it will request that the EU bring an action in the World Trade Organization. One suspects many countries won’t have the patience for such niceties. They will just retaliate by blocking U.S. product.

In times of economic stress, protectionist policies always have appeal, and populist politicians always run to protectionism to appear as defenders of the “common man.” But it is a horrible mistake.

Like it or not, prosperity depends fundamentally on trade. If any country tries to rope itself off from the world it will impoverish itself and its neighbors. The economic principle known as comparative advantage means each country is better off producing the product it is best at and trading for what it still needs, rather than trying to do everything itself.

Members of the international trade community have a special responsibility at moments such as this to communicate the importance of trade with policymakers. We must make our voices heard, not only to save our own businesses but to ensure that a recession is not made much much worse by policies certain to fail.