“When the Patient is Dying, First Stop the Bleeding.”
© December 6, 2008

In times of severe national economic crisis it is not unreasonable for the government to provide emergency “stimulus” to the economy, but poor understanding of economic fundamentals can lead to foolish “stimulus” plans that fail to stimulate, and must certainly have unintended negative consequences.

It has become popular lately, especially among politicians on the left, to call for the Congress to pass a “Stimulus Package” of spending on “infrastructure projects;” government spending on roads, bridges, and other projects. Without a doubt, this spending does create some jobs for some industries that have been hurt by the economic recession. The theory is that these are projects from which the whole public derives some benefit, and the positive effects on these narrowly targeted industries will have some stimulative trickle-down effects on other industries. The construction worker buys a new pair of boots, a fast-food burger for lunch, or maybe even a new truck, all good things. The question we must ask as wise students of basic economics, is: What does a rigorous “cost / benefit” analysis say about this plan, and is there any better plan?

The most immediate benefit goes to the contractors and suppliers who build these projects, but these are just a few of the millions of participants in the economy. Selfishly, it immediately occurs to me that I do not build roads or bridges, or produce any of the raw materials that go into these projects. True, I do drive on roads and bridges. I spent an hour or two on roads, and drove across a bridge or two just today, but in the last month as I have contemplated how the current economic downturn might affect my family, I do not honestly remember asking myself, trembling, “What if the government does not build a new road or bridge for me to drive on?” My memory is not what it once was, but I just cannot remember any urgency attached to such a thought. Now that the left has recommended this “urgently needed stimulus plan,” forcing me to contemplate how it might affect me in the coming weeks and months as these new infrastructure projects get started, I suppose in the coming months I might have a new opportunity to wave at a friendly construction project flagger, after a brief delay on my way to work. And in six months or a year or two, maybe I will get to drive on a shiny smooth new road or bridge… Hummm… I guess that would be nice, sort of. But, honestly, it just does not give me shivers of enthusiasm for the wonderful help it will be as I try to pay my bills, and worry if I might be laid off from my job. As an “urgently needed” miracle cure for our current economic woes, it leaves me, underwhelmed.

The first problem with this “stimulus” policy then, is that it singles out a few categories of workers and industries to offer stimulus which of course they will undoubtedly appreciate, but it fails to provide meaningful immediate help to the thousands of other industries and millions of other workers who are also experiencing a very difficult economy. Not that smooth asphalt and friendly flaggers aren’t nice, but they seem entirely insufficient to the economic challenges facing us.

To understand the larger problem with this government spending “stimulus” policy, requires a bit of clear economic thinking. Any time the government gives money to one group, that money must have been taken from another group. It may come as a shock to some, but the simple truth is that, THE GOVERNMENT HAS NO MONEY OF ITS OWN! If the government would give me a dollar of services, it must first take a dollar from you to pay for it, but like any “service provider,” government services include very large “overhead” expenses. In order to spend a dollar on someone the government wants to help, they have to take about a dollar and a half, or more, from someone else. Even if you have stimulated one small segment of the economy by a dollar, the vast bulk of the rest of the economy has not been “stimulated” by a dollar, but rather “starved” by that same dollar, plus a half a dollar or more of unproductive government overhead. It must surely be uncontroversial that government overhead is not in and of itself “productive;” it creates nothing to add to the gross domestic product of the nation, it is at best a transfer of value with some loss.

To illustrate the point, imagine that a patient comes to the hospital emergency room having lost so much blood that he needs a transfusion. If the doctor inserts a transfusion needle in one arm to deliver fresh blood, and then connects the other end of the transfusion tube to a needle in the other arm of the same dying patient, we would think he was quite foolish. Clearly this is not going to help. But if the doctor then cut a small hole in the middle of the tube so that a large portion of the patient’s own blood leaked out, we would be justified in concluding that the “doctor” was not just foolish, but was contributing to the imminent death of the patient.

On the other hand, it is not unreasonable for the government to want to help stimulate the economy, and there are useful things that government can do. If the government is concerned about rising rates of unemployment, and limited business capital, the answer is to let businesses keep more of their own money. The capital gains tax on business in this country is 35%, one of the highest rates among all developed countries. The business income tax rates are 15% to 35%, the higher of these rates again being among the highest in the world. If the government really wants to stimulate the economy, why not reduce the top business tax rates to 10% immediately, tomorrow, and reduce tax rates on small businesses to zero to stimulate the creation of new businesses. Congress could pass that bill, the President could sign it, and it would begin to have an effect almost as soon as the ink had dried. All businesses, in all industries, could immediately begin planning based on the knowledge that they would be able to keep as much as 25% more right from the bottom-line profits of their company and from every capital gains transaction. If they were worried about needing to lay off workers, they could immediately announce that it would not be necessary. If they had put off growth plans due to the slowing economy, they could immediately turn those decisions around. Many businesses who had been concerned about an inability to borrow the liquidity needed to run their business, could fund their business immediately from a 25% increase in their own net cash flow. Better yet, with a business tax cut, there is no “overhead” loss to the overall economy. One hundred percent of the benefit of the tax cut would immediately be injected into every industry. Every worker in the nation would immediately be more secure. At these rates, the USA would have one of the lowest business tax rates of all developed countries. Multi-national companies making choices about where to expand their operations, would be far more inclined to do so within the USA instead of going offshore. Industries involved in global trade would suddenly be as much as 25% more profitable relative to their global competition. Small businesses could get started or continue to grow much more easily.

Can anyone fail to recognize this basic truth of fundamental economics? The largest experiment in the history of government “stimulus” spending on “infrastructure” was FDR’s “New Deal,” which utterly failed to stimulate the economy. A decade after the 1929 crash, the economy still had very large double digit unemployment and was still experiencing the longest and deepest economic downturn in the history of American capitalism. The great depression was not “cured” until after World War II had changed the entire global economic landscape.

To return to our medical analogy, at 35% tax rates, the patient – our ailing economy – has been receiving the economic equivalent of the medieval medical treatment once known as phlebotomy, blood-letting, that was once thought to drain sickness from the body. Medical science long ago learned that blood-letting only weakened the patient and made recovery much slower and more difficult. It is basic first-aid training that the first thing to do with an injured patient is to stop the bleeding. Our politicians, especially those on the left side of the aisle, should learn this same lesson, from medicine, and economic history: In the midst of a serious recession, if businesses are struggling and unemployment is rising, the right treatment is to stop the bleeding.