What's stimulus, anyway? A simple user's guide

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In 1971, Richard Nixon famously declared, "We are all Keynesians now." Yet, even as he spoke those words, the economics profession (led by Milton Friedman) was turning sour on government intervention - celebrating, instead, the self-correcting virtues of the free market.

Suddenly, however, the pendulum's come flying back. It's awfully hard to praise unregulated markets these days. And "stimulus" is the economic flavour of the month. Politicians of all stripes are on the bandwagon - even many who, until six months ago, derided the very concept. Our own Finance Minister, Jim Flaherty, is now putting the finishing touches on a budget that, he will claim, does its share of "stimulus."

In this environment, politicians - desperate to show they are doing something - will dress up anything as "stimulus." So with stimulus flying thick and furious, this is a good time to take a deep breath and ask some basic questions. What is "stimulus," anyway? What works best? How much do we need, and for how long?

To that end, herewith a User's Guide to Stimulus, to help worried Canadians disentangle the stimulus from the spin.

Lesson #1: The basic idea of stimulus is to generate more spending (hence more production and jobs) than otherwise would occur. It's needed when spending by one or more major players (consumers, businesses, governments) suddenly declines. If a new policy doesn't produce more spending (the quicker the better), then it's not stimulus.

In this context, Mr. Flaherty's astounding claim that his new Tax Free Savings Accounts are stimulus (because they "leave more money in peoples' pockets") was precisely wrong. Encouraging people to save is the opposite of stimulus: We need shell-shocked consumers to spend money, not leave it in their pockets.

Lesson #2: The more leakages from the pipeline, the less stimulus a policy delivers to the end destination. Consider, for example, corporate tax cuts (which business lobbyists are now selling as "stimulus"). How do they boost spending?

First, the company has to be profitable (otherwise, a tax cut is worthless); that excludes the hardest-hit sectors. Second, the company must need new capacity. Otherwise, it won't boost investment, no matter how attractive the tax regime. Much of this "stimulus," therefore, leaks out to debt repayment or cash hoards. If the goal is stimulating business investment, better to do it with grants and credits tied directly to incremental spending. Even personal tax cuts are ineffective, if shell-shocked consumers sock away their savings for the rainy day they're fearing.

Lesson #3: Stimulus targeted at Canadian-made goods and services gets more bang for the buck. Handing out $100 gift certificates for Wal-Mart would stimulate spending all right - on stuff made in China. Better to channel money into things we do right here. Infrastructure (from public transit to green energy to repairing schools in first nations communities) scores very high on this count.

Lesson #4: Sooner or later, stimulus must be turned "off." The aim is to moderate the ups and downs of the private sector, and so we must be able to withdraw the stimulus once the overall economy rebounds. This might be in two years (if we're lucky); more likely, we'll need stimulus for five. But no stimulus package lasts forever. In this light, think twice before accepting the argument that permanent, broad-based tax cuts are "stimulus." Sure, it's good fun to deliver those goodies now. But pity the finance minister down the road who has to take them back.

So when Mr. Flaherty and others stand up to promote their respective packages, evaluate their claims in light of these simple lessons. How will they boost spending on Canadian goods and services? How quickly? And can they be turned off when the need for stimulus passes? Otherwise, we'll get nothing more than what the politicians wanted to do all along - now justified in the all-encompassing name of "stimulus."

Jim Stanford is an economist with the CAW.

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