Neither Stimulus Nor Austerity Will Solve This Crisis: A Third Way?

Few subjects have so bitterly divided our insecure times than the double-edged saber of stimulus vs. austerity. Consensus over which course will lift the current economic malaise has eluded the dueling experts. Without clearer signals of success, many nations have tried a confused mix of both – let’s call it “aust-imulus.”

While I tend to lean Keynesian, the case for fiscal stimulus is hardly the slam-dunk that its most strident proponents make it out to be. Nobel Prize-winning economist Paul Krugmanbases much of his call for huge amounts of stimulus on the American experience during the Great Depression. In Krugman’s view, the policy intervention that finally lifted the sinking boats was an unprecedented amount of wartime spending by the government.

Krugman has written, “Deficit spending created an economic boom – and the boom laid the foundation for long-run prosperity.”

But this viewpoint ignores a fairly obvious counterpoint. The United States emerged from World War II as the world’s conqueror, with virtually every economic competitor destroyed. Suddenly, America was the big boy on the block, leader of the Pax Americana, and our industries enjoyed numerous competitive advantages over international rivals. The dollar, suddenly, was the dominant global currency, and that granted Americans cheap money and influence that spurred unprecedented economic growth.

In addition, we then launched the ambitious Marshall Plan, which not only rebuilt our former adversaries, but also created international markets for US producers. One of the Marshall Plan’s conditions was that nations receiving funding were required to give American exporters preferred access to their emerging markets. The years of the Marshall Plan, from 1948 to 1952, saw one of the fastest periods of growth in European history, with industrial production increasing by 35 percent and agricultural production substantially surpassing prewar levels. American businesses, especially those specializing in manufactured goods and raw materials, benefited greatly from these fast-emerging markets. Any massive stimulus plan today would not benefit from those same advantages.

Krugman has rejected this critique, writing, “Trade was a minor factor in the American economy both before and immediately after the war, with imports and exports a much smaller share of gross domestic product than they are now.” Krugman admits that there was an increase in trade for a few years in the late 1940s due to the effects of the Marshall Plan, which allowed ruined economies to buy more from the United States, but it’s impact “was temporary,” he says.

But Krugman’s response is unconvincing. Here is a simple thought experiment to illustrate why. Imagine if America had lost World War II and not emerged as the dominant power. Does anyone seriously believe that all of that wartime stimulus money would have resulted in anywhere near the post-war boom that the United States experienced? Krugman is underestimating the impact of being the world’s conqueror, and the financial, economic and psychological advantages that conveys.

Certainly, a large dose of fiscal stimulus right now would spur an increase in aggregate demand, but without a surging export sector, that would probably result in more government jobs (and perhaps more than a few “bridges to nowhere”) than private-sector jobs. There’s no guarantee it would boost private-sector growth, since America’s struggling export and manufacturing base still would face stiff competition from many upstart international rivals, with none of the advantages enjoyed by US exporters in the aftermath of World War II. The world today, and America’s position in it, are far, far different from what they were in 1945.

In addition, the financial scale of both wartime funding and the Marshall Plan were astronomical. Krugman himself estimates that “over the course of the war the federal government borrowed an amount equal to roughly twice the value of G.D.P. [gross domestic product] in 1940 – the equivalent of roughly $30 trillion today,” four times the amount of President Barack Obama’s fiscal stimulus in 2009. Historian Niall Ferguson has estimated that the total amount disbursed under the Marshall Plan was equivalent to roughly 5.4 percent of US gross national product, or over $800 billion in today’s currency, about the same as the Wall Street bailout in 2008. Both are staggering sums, and politically untenable today unless the Occupy Wall Street movement grows by a thousandfold, which seems unlikely. Stimulus hawks might as well be proposing that we command the earth to spin backwards.

In short, the world is decidedly multipolar now, and even if it was possible to pass a massive stimulus plan through the US Congress, there’s simply no guarantee that it would have an equivalent positive impact without the favorable conditions that existed after the Second World War.

Military Spending = Wasted Stimulus

The stimulus hawk position also fails to realize that a lot of stimulus spending already is occurring on a regular basis – courtesy of the hugely bloated US military budget. It is widely known that the United States spends as much money on its $700 billion annual defense budget as the next 20 nations combined, and three times more than all conceivable enemies combined (and that figure does not include spending for theatre of war operations in Iraq, Afghanistan and Libya, which amounts to another estimated $1 to $3 trillion, nor does it include huge expenditures by the Department of Homeland Security (DHS), National Security Agency (NSA), the CIA, the Veterans Administration, or the parts of the National Aeronautics and Space Administration (NASA) and the Department of Energy used for military-related activities).

Yet, not all of these military expenditures contribute much to national security, since vast sums are being spent on outmoded weapons systems, such as 11 large aircraft-carrier battle groups and other obsolete military hardware which military experts say are “still geared to fight the imperial navy of Japan.” Even the Bush administration’s top intelligence analyst concluded that US military superiority will “be the least significant” asset in the era that is unfolding.

So, what, then, is all the military spending for? In reality, a substantial part of it is nothing more than a jobs program targeted to Congressional members’ home districts. The US economy has become hooked like an addict to an ongoing fiscal stimulus from military expenditures. Yet, as a fiscal stimulus, military spending is extremely inefficient. For starters, you are building a product – weapons – that you hope to never use, so the market for future sales faces severe constraints. And many of the million-plus US soldiers in uniform are stationed overseas, where they are spending their salaries in some other nation’s economy. For all these reasons and more, many studies have shown that the economic “multiplier effect,” which causes each dollar spent to ripple through an economy, is much higher for spending on physical infrastructure – maintaining roads, bridges, airports and harbors, construction on which the American Society of Civil Engineers says the United States has fallen $2 trillion behind. Even a small reduction in military spending to the same share of GDP as it was in 2000 would save $240 billion a year, or 1.6 percent of GDP. That’s a decent chunk of stimulus money in waiting.

So, if Americans want more stimulus from their broke Treasury, they will have to snatch it away from the military budget. It makes little sense to talk about more stimulus and running up more debt without making conversion of defense dollars to civilian needs a core priority. But even stimulus hawks like Krugman have not been willing to touch that sacred cow.

Environmental Costs of Boosting Consumerism

The stimulus hawks also don’t bother to consider the environmental impact of their policies. The dilemma the world faces can be summarized by this simple equation:

More stimulus spending = more consumption = more carbon pumped into the atmosphere.

The fact is, this economic crash has provided a big breather for the planet’s increasingly carbon-choked environment. This is especially important in the United States since, like the Bush administration, President Obama has done little to push Americans to rein in our carbon-belching ways (the average American still emits twice the amount of carbon as the average European or Japanese, and four times that of the average Chinese, the United States being, by far, the largest per capita emitter of carbon in the world). The stimulus hawks refuse to address the environmental impacts of their approach, saying only that it is necessary to prioritize economic growth and job creation first before dealing with the longer-term challenges of global warming.

Seeking a Third Way: Neither Stimulus Nor Austerity

Steering between the twin horns of austerity and stimulus, the world must grope toward a third way that allows advanced economies to provide for their people without roaring growth rates driven by asset bubbles, hyperactive consumption and carbon-belching activities. Simplistic arguments that pit stimulus against austerity are unhelpful. There is no easy, ready-made, one-size-fits-all solution to this challenge. Each country and economic bloc must choose its own course, which will probably involve a degree of toughing it out, austerity-like, but also doses of targeted stimulus – “aust-imulus.”

To be clear, I am not advancing a conservative argument against stimulus, deficits, public credit or government debt writ large; instead, I am interested in a conversation about degree and kind. Stimulus and public debt can be immensely advantageous, such as when they are invested in infrastructure and education that make economies more competitive and pave the way for the future. Too much of an austerity brake can also cause or exacerbate problems, leading to more recession, deflation and job loss, as even the International Monetary Fund (IMF) has finally admitted. But merely spending more money that the government doesn’t have is not a solution in the absence of a broader plan, an inspiring vision and a bigger narrative that explains how not only more spending, but a rejiggering of budget priorities, will help.

In Europe, once a critical number of member states have ratified stricter fiscal and budget rules – thus becoming more like America’s member states, which are each required to balance their state’s budget – look for the EU to reshuffle its “aust-imulus” program. That will likely involve the deployment of eurobonds or a debt assumption role for the European Central Bank (ECB) or some other form of debt sharing, as well as targeted stimulus of some kind for the struggling periphery. The final form may have to wait until the 2013 elections and a change in Germany’s government, but it surely is coming.