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April 7, 2009 9:28 AM

Stimulus Spending Won't Help U.S. Industry Restructure Itself

By
Tyler Cowen
(MoneyWatch)  I am struck by the fact that most European nations are skeptical about massive fiscal stimulus spending. Those countries are hardly dogmatic paragons of laissez-faire or wary of government spending overall. But I think they see, through historical experience, that when an economy has serious structural problems, the "borrow and spend" approach is more a temporary bandage than a solution.

As the crisis progresses in the United States, we are seeing it is much more than just a financial crisis or a housing crisis. For instance, most of the U.S. automobile industry requires restructuring. The sales crisis in autos was triggered by the broader downturn, but the problems of GM and Chrysler are longstanding and not just the result of the current shortfall in consumer spending.

Elsewhere, it is not only finance and construction which need new business models but also significant portions of health care, energy, education, and the media and entertainment sectors. Many -- or indeed most -- of these changes can end up being positives in the longer run, but their short-run adjustment costs will be wrenching. That is why this recession is turning out to be so much more severe than many of the early projections indicated.

It is a standard result in macroeconomics that fiscal stimulus works best when the fundamental economic problem is a shortfall of consumer spending. Fiscal stimulus works much less well when the business cycle is caused by the sectoral shifts of the economy-namely the reallocation of workers from an old set of jobs to a new set of jobs. The key is not more spending but rather finding out where the new jobs will come. I don't think government is especially good at entrepreneurship and thus I am a relative skeptic when it comes to President Obama's plan for fiscal stimulus.

A moderate stimulus can limit some of the fallout from the adjustment process, but a very large stimulus will not, under these conditions, drive recovery. That's why I favor only a moderate stimulus. I am very nervous about plans for an extra $1 trillion or so in stimulus spending.

The common claim is that the Europeans won't engage in fiscal stimulus because they are "free-riding" upon the spending efforts of the United States, and perhaps China. But even a small country, such as the Netherlands, could make targeted fiscal policy work if indeed fiscal policy is what is called for. The Europeans think we need some different remedies. I agree.

Fixing the real economy can be difficult and it doesn't always give politicians a lot of goodies to hand out. In fairness to the Obama administration, it does have some very ambitious plans for restructuring energy and health care. I don't yet see that those plans will work, but if they do they will prove much more valuable than the current stimulus package or even the next stimulus we might come up with.

Follow Blog War over the federal stimulus package:

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