Costs of the stimulus
2009-01-13 · Original WordPress address
Most criticism of the fiscal package have centered on its impotence: consumption smoothing agents will make it moot or it's effects won't be seen in time to make a difference. So we've all been talking about multipliers. There's a possibility, though, that the stimulus actually does harm:
Stimulus plans that bailout the financial and auto sector will influence innovation and reallocation. Reallocation may particularly suffer if the stimulus plans lock in factors in low-productivity sectors and activities. Market signals suggest that labour and capital should be reallocated away from, for example, the Detroit Big Three and highly skilled labour should be reallocated away from the financial industry towards more innovative sectors. Halted reallocation will also mean halted innovation.
Not only are we saddling future generations with debt, but we may be making them poorer than they might otherwise have been. Economic efficiency is generated through sectoral reallocation and efficiency creates growth. Even small reductions in efficiency have huge effects in the long run. For example, suppose the fiscal stimulus solidifies the expectation that big firms are too big to fail. This will cause too many resources to be allocated to big, established firms where innovation isn't as hectic. Even if this has a small growth effect --- let's say it reduces growth rates by 0.3% --- it only takes a generation for this swamp out the size of the additional debt created by the stimulus package.
As we saw in the global warming debates, this point is almost impossible to get across. Future growth is particularly intangible for most people.