The Public Policy

The Stimulus Delusion

Officially stimulus spending adds to the GDP. In fact, it is bleeding us dry.

By 10.25.11

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Popular delusions are always debunked, but rarely before they do a lot of harm. The ancient physician Galen believed that bloodletting, the forced removal of blood from the body by the opening of a vein, could remove excess blood from the body and improve health. Countless sick people suffered for this delusion until the English doctor William Harvey realized that blood circulated through the body in the 1620s (although the practice continued for some time, with even Founding Father Benjamin Rush being an enthusiast). Today, the American economy suffers from a similar form of quackery.

There is now evidence that the process of Keynesian stimulus spending is just as harmful to the body politic. For nearly a century, politicians have been bleeding the economy when it has been at its sickest. To cure this delusion, just as physicians stopped talking about bodily humors, we need to stop talking about gross domestic product (GDP).

Our William Harvey is the economics professor Burton Abrams, who, in a new article for the Economists' Voice, reveals that the American Recovery and Reinvestment Act, the $800 billion "stimulus act," actually made the nation worse off by at least $475 billion. That figure alone should stop the current calls for stimulus stone dead.

The reason it cost so much is because, although some public debt can be beneficial, economists now recognize that once public debt reaches a certain level it becomes a drag on the economy. So debt-funded stimulus, of the sort that Keynesian physicians prescribe for a weak economy, can be exactly the worst thing to do if debt is already at high levels.

American debt is already above all the "tipping points" postulated by economists. Therefore, the increase in debt to fund the stimulus has reduced our long-term growth rate by a present value of $1.875 trillion.

If we believe the Keynesians, and accept that every dollar of public money spent in the stimulus did stimulate $1.75 of economic activity, we see that the stimulus provided $1.4 trillion of benefits. So Abrams's $475 billion is in fact a best case scenario. Of course, there is a strong possibility that the stimulus did not provide anywhere near the benefits claimed. If the stimulus didn't work and just wasted money, as most free market economists believe, then the cost was even higher.

The reason why we fall for the Keynesian argument for stimulus every time (President George W. Bush did, too) is that our main measure of economic well-being, gross domestic product, is designed to respond well to stimulus spending. The amount of stimulus spending is simply added to the GDP figure, with no accounting for the effects of debt. That stimulus increases GDP is a self-fulfilling prophecy.

To shake off this stimulus delusion, we need a new metric. Martin Hutchinson, co-author of the brilliant book, Alchemists of Loss: How modern finance and government intervention crashed the financial system, has suggested that we instead consider what he calls gross private product (GPP). GPP measures the value of transactions between a willing seller and a willing buyer, so activities that occur only because government wants them to, like ethanol mandates, do not count. GPP tells a much different story about Keynesian success stories, like the Second World War, and makes much more sense.

Without a shift away from GDP as our main measure of growth, we will continue to see politicians calling for stimulus and claiming success when GDP goes up, even as our economic welfare suffers. William Harvey's discovery led to the use of blood pressure as a vital sign -- a much more accurate assessment than the balance of "humors." While people still insist on the efficacy of debt-funded stimulus and the relevance of GDP, we will remain stuck in the economic dark ages. 

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About the Author

Iain Murray is Vice-President for Strategy at the Competitive Enterprise Institute.