Obama’s bogus economics

By Joseph Beaudoin

President Barack Obama continues to insist that his stimulus plan will create or save 3.5 million jobs but he has not explained how he arrived at this number.  In fact, nobody has done that in a convincing manner because it cannot be done.  Mr. Obama's stimulus plan is a pipe dream based on economic assumptions known theoretically and empirically to be false.

The 3.5 million jobs stem from an economic model built by Christina Romer, chair of the White House Economic Advisory Board, and Jared Bernstein, economic advisor to the vice president elect. The Romer-Bernstein model goes a long way to revealing why Mr. Obama would rather talk about the 3.5 million jobs than about how these jobs came into projected existence.

Romer-Bernstein is a Keynesian macroeconomic model based on the following critical assumptions:

1. 1.A multiplier averaging 0.82 for to tax cuts;  

2. 2.A multiplier averaging 1.5 for government spending;  

3. 3.Interest rates to be zero for four years;  

4. 4.Government spending causes no crowding out. 

Multiplier

The “multiplier” is a Keynesian concept used to quantify the effect of government policies on the GDP.  For instance, should it have a 1.5 multiplier, government spending equivalent to 1 percent of GDP would create a 1.5 percent increase in GDP.  Needless to say, socialist economists love the multiplier.

Oddly, Romer-Bernstein’s multiplier assumptions are not borne out by Mrs. Romer’s previous work.  In a paper published in March 2007, Mrs. Romer and her husband, David H. Romer, found that tax cuts have a multiplier of three in normal economic times but they are ineffective when used to offset a business cycle.  In other words, Romer-Romer found that tax cuts do not work during recessions – ostensibly, because consumers choose to increase their savings.

The Romer-Romer paper constitutes a major blow to Keynesian economics because its findings can be applied to government spending as well. Hence, Romer-Romer provides the best argument against Romer-Bernstein's 3.5 million jobs, namely, that fiscal policies do not work during recessions.

In a recent paper, economists John F. Cogan, Tobias Cwik, John B. Taylor and Volker Wieland (Cogan-Taylor) assessed Romer-Bernstein with a Keynesian model that incorporates the major economics findings of the past 30 years, including rational expectations. They found that the multipliers for government spending was only one third of the multipliers Romer-Bernstein assumed and, most significantly, multipliers become negative in 2013 for several years thereafter.  The inescapable conclusion is that government spending will eventually impoverish the country.  This explains why countries that relied on government spending for growth became poorer.

It seems that Mrs. Romer and Mr. Bernstein disregarded reality and simply set their multipliers at levels that would ensure a predetermined outcome, namely, Mr. Obama’s 3.5 million jobs. Government spending multipliers of 1.5 are to economics what unicorns are to zoology: they are mythical.

Zero interest rates

Romer-Bernstein makes another outrageous assumption, i.e. that interest rates will be zero for four years. In theory and in practice, interest rates can only be at zero during a period of no or of very slow growth. As Romer-Bernstein projects strong GDP growth, it is inconceivable that interest rates would remain at zero for four years.

That assumption is even more problematic when one factors in the Federal Reserve’s inflationary activities of the past year. The combination of strong growth and the Fed easy-money will make it impossible for interest rates to remain at zero.

Romer-Bernstein’s interest rate assumption is, therefore, indefensible within the parameters of their model. It also contradicts basic interest rate theory.

No crowding out effect

Mr. Obama, while embarking on the largest peacetime government spending programs, pays lip service to the private sector and assures Americans that he wants a strong private sector.  Accordingly, Romer-Bernstein projects that the private sector will create 90 percent of Mr. Obama’s 3.5 million jobs. Economic history, however, does not bear that assumption out.

It is an empirical fact that government spending reduces—crowds out—private private sector economic activity. It is, therefore, hard to imagine how a government spending program that will crowd out private sector economic activity by hundreds of billion of dollars will, at the same time, get the same private sector to create 90 percent of the 3.5 million new jobs.

In contrast, the Cogan-Taylor model suggests that Mr. Obama’s stimulus plan will only create 600,000 jobs and that the private sector contribution will be minimal.  In other words, Mr. Obama will spend almost $800 billion to create 600,000 mostly-government jobs. That means each Obama job will cost American taxpayers over $1.3 million and will disappear soon after the spending is done.

In order to create the promised 3.5 million jobs, Mr. Obama would have to increase the stimulus plan to $4.2 trillion. That would be 33 percent of the U.S. Economy.

Models versus reality

Ultimately, models are as good as their assumptions. That is why Mr. Obama’s 3.5 million jobs will never materialize. The model upon which these jobs are based is so seriously flawed as to have zero credibility. Government spending will prove just as ineffective in this recession as it did in other recessions, in the United States and elsewhere. There is no empirical evidence that demonstrates that government spending creates prosperity. The opposite is true.

Plenty of countries, from Argentina to Zimbabwe, have repeatedly and over several decades tried to spend their way to prosperity.  The results have been consistent.  Government spending increases debt, shrinks the private sector and impoverishes the nation.

While the experiences of bankrupted states like North Korea and the former U.S.S.R. come to mind, one does not have to go far to observe failures similar to those in which Mr. Obama’s policies will result.  Some of our European allies were, for decades, ardent proponents of government spending. They moved away from such policies because they were going broke. Italy’s experience ought to be a lesson for Congress, the White House and the brand of economic theory they have embraced.

By pursuing discredited economic policies, Mr. Obama is putting the United States on the road to economic irrelevance. His upcoming budget, building on the stimulus plan, will bring America closer to destitution. Perhaps Congress will stop this madness before it is too late.

- Joseph Beaudoin holds degrees in economics and finance, and worked in the banking and investment industries for 20 years. He is a regular contributor to Reflections.