Neville Bennett PhD Weekly Newsletter

February 12, 2009 Brought to you by TGN Fund Distributors | www.tgn.co.nz

Cash Carpet Bombing

by Neville Bennett

Alfred, Lord Tennyson, a core poet in my life, once asked “Am I your debtor?’ This is the question that taxpayers now should be asking their governments, for government leaders seem determined to spend, spend, spend with little thought for the quality of their expenditure and the future burden. Cash carpet bombing is in vogue, and as Mrs. Thatcher always said-“there is no other way”.

Mr. Obama stimulated my thoughts by conceding that his current stimulus package is 90% social and 10% economic. He jeered at his critics: “So then you get the argument, So then you get the argument, well, this is not a stimulus bill, this is a spending bill. What do you think a stimulus is? (Laughter and applause.) That's the whole point. No, seriously. (Laughter.) That's the point. (Applause.)"

So there it is: The Wall Street Journal accuses Mr. Obama of endorsing a reductionist Keynesianism that argues that any government spending is an economic stimulus. I believe that it matters what the money is spent on, and how the finance is raised. If the Government gives the aged a dollar (as Australia and Japan are doing) the authorities have to take that dollar off someone else. They can do this by increasing taxes or issuing debt.

Let us look at the people affected in our simple model. Pensioner A spends a dollar. Taxpayer B provides that dollar, either through tax or a bond. Taxpayer B will have $1 less to spend. If Pensioner A spends her $1 on something less productive than the taxpayer would have, then the net impact on growth will be negative. Not only will it be negative, but it may not stimulate productivity. Concerns about productivity could get lost in the panic that has seized our leaders. (New Zealand leaders, incidentally, seem more sagacious than elsewhere.)

Cash carpet bombing pensioners is politically popular in many countries because this growing demographic segment has great voting power. But in most of the wealthier countries the aged are relatively advantaged in terms of both wealth and income. These actions lack equity. In Australasia, the elderly has a high propensity to travel, and spend their dollar overseas or on imports, which does not stimulate the domestic economy.

Much of the various stimulus packages are transfer payments; they are grants or benefit payments made as gifts. They are not payment for productive services. They are part of income redistribution and they are not a return to the factors of production.

The US package has an emphasis on helping the poor (through unemployment compensation, health care and food stamps) because it is believed an increase in their income will stimulate spending and be good for employment. The Democrats are inclined to think the better off might save a benefit or reduce debt. This view neglects the benefits of saving and accumulating capital which can stimulate new business.

Some stimulus is undoubtedly necessary. The US economy hit the wall in the last quarter of 2008 with massive job cuts and a deepening housing crisis. Home prices dropped at their fastest rate in 18 years, and new starts were the lowest since records began. There are a record number of foreclosures, and one in six mortgage owners have negative equity. In my view the housing crisis is gaining momentum and the number of jobless is escalating.

The Obama package should help confidence: everyone gets something: a $15,000 tax –credit for homebuyers, a concession for car-buyers, and a $1000 tax cut for working couples, and increased tax-credits for low-income workers with children, and a $500 tax cut for all individuals. However, cuts at the weekend omitted $20 billion for construction and repair of schools and universities: odd, as that expenditure would have helped the ailing construction industry. The package also improves infrastructure though tax-breaks for wind and solar power generation, repairs to roads and bridges, and funds for home insulation.

Mr. Obama's Republican election opponent Senator John McCain has been one of the most outspoken opponents of the stimulus package, branding it as "generational theft" that contained billions of wasteful spending and boondoggles. "We are going to amass the largest debt in the history of this country and we are going to ask our kids and grandkids to pay for it," he told CBS. "I know America needs a stimulus but this is not it."

Pointed criticism comes from Michael Porter, the doyen of management gurus who teaches at Harvard Business School. I support his view that there is a need to stimulate the American economy, but with better targeting. The aim is to give the economy a jolt, but Porter argues that the extra government spending in the package (on unemployment, health, transport and education) is “the usual pork –barrel favourite projects”.

Porter sees a missed opportunity: America should look at challenges to the economy and invest in change. In particular, it should focus on “issues which would be critical constraints to our future”. Porter’s emphasis is on access to higher education, and remedying a neglect of research and development. He considers that the US has never dealt with its serious problems, especially reducing the cost of university education.

He sees Obama’s programme as ill-considered. He suggests that the stimulus include student loans and grants to supports kids going to college (The package does this!), and also grants to allow some people to retrain. This provides an immediate stimulus and invests in a fundamental priority. If it misses the education priority,”the country is going nowhere”.

My concern about UK debt was expressed last week (Click here to view) It will raise taxes for a generation. The merit of the British plan is that it pays off debt: this reduces inflation. The Obama carpet-bombing plan is entirely debt funded. It slashes the cost of borrowing for this generation and transfers the pain to another. Moreover, it arouses the suspicion that debt will be inflated away.