Stimulus Thinking, and Nuance
By DAVID LEONHARDT
Published: March 31, 2009
Every so often, history serves up an analogy that’s uncomfortable, a little distracting and yet still very relevant.
In the summer of 1933, just as they will do on Thursday, heads of government and their finance ministers met in London to talk about a global economic crisis. They accomplished little and went home to battle the crisis in their own ways.
More than any other country, Germany " Nazi Germany " then set out on a serious stimulus program. The government built up the military, expanded the autobahn, put up stadiums for the 1936 Berlin Olympics and built monuments to the Nazi Party across Munich and Berlin.
The economic benefits of this vast works program never flowed to most workers, because fascism doesn’t look kindly on collective bargaining. But Germany did escape the Great Depression faster than other countries. Corporate profits boomed, and unemployment sank (and not because of slave labor, which didn’t become widespread until later). Harold James, an economic historian, says that the young liberal economists studying under John Maynard Keynes in the 1930s began to debate whether Hitler had solved unemployment.
No sane person enjoys mixing nuance and Nazis, but this bit of economic history has a particular importance this week. In the run-up to the G-20 meeting, European leaders have resisted calls for more government spending. Last week, the European Union president, Mirek Topolanek, echoed a line from AC/DC " whom he had just heard in concert " and described the Obama administration’s stimulus plan as “a road to hell.”
Here in the United States, many people are understandably wondering whether the $800 billion stimulus program will make much of a difference. They want to know: Does stimulus work? Fortunately, this is one economic question that’s been answered pretty clearly in the last century.
Yes, stimulus works.
When governments have taken aggressive steps to soften an economic decline, they have succeeded. The Germans did it in the 1930s. Franklin D. Roosevelt did so more haltingly, and had more halting results. Even the limp Japanese recovery plan of the 1990s makes the case. Although dithering over a bank rescue kept Japan in a slump, government spending on roads and bridges made things better than they otherwise would have been.
No matter what happens in London on Thursday, President Obama and other world leaders are sure to claim the meeting as a success. (“I do not regard the economic conference as a failure,” Roosevelt said in 1933.)
But if the meeting is going to be an actual success, it will have to do more than put a happy face on trans-Atlantic disagreements. It will need to begin nudging the discussion about stimulus toward a more accurate reading of history.
The Americans and Europeans aren’t really as far apart as Mr. Topolanek’s AC/DC homage suggests. Europe is doing less than the United States, but the gap isn’t huge. It just seems so because European stimulus tends to arrive quietly, from existing safety net programs. In this country, where the safety net is weaker, stimulus comes largely from new laws.
Yet the rhetoric from Europe " even the more subdued recent remarks, like those of Chancellor Angela Merkel of Germany " still creates a problem. Stimulus skepticism today will make it harder to pass more stimulus tomorrow. And more will probably be needed.
George Soros, the billionaire investor who was born in Budapest and works in New York, came to Washington last week and captured both the problem and the potential for a solution. “I think they can be brought around,” he said of the Europeans. “I am actually hopeful something constructive can happen.”
The objections to stimulus tend to come in two forms: Its costs are too high, and its benefits too small.
Mr. Topolanek and German officials have been pressing the first argument. They say that the additional government spending can lead to inflation and government debt. The Weimar Republic of the 1920s, where inflation helped lead to Hitler’s rise, casts a long shadow.
Stimulus opponents here in the United States " mainly Congressional Republicans (though not, tellingly, Republican governors of some large states) " have been warning about debt, too. But they have also been making the second argument. When the government spends money, they say, it simply displaces spending by the private sector. Republicans on Capitol Hill have taken to citing a recent book by the journalist Amity Shlaes, “The Forgotten Man,” which claims the New Deal didn’t work.
Theoretically, neither of these arguments is crazy. But they don’t have much evidence on their side.
The best takedown of Ms. Shlaes’s thesis came from Eric Rauchway, a historian, who pointed out that her favorite statistic did not count people employed by New Deal programs to be employed. Excluding the effects of the medicine, the patient is as sick as ever!
When Roosevelt stuck to a stimulus program, unemployment fell markedly, and the biggest stimulus of all " World War II " did the rest. It’s true that economic models say the economy shouldn’t work this way. When resources are sitting idle, businesses should find a way to use them profitably. But they often don’t.
People become irrationally pessimistic during a downturn. They are driven by what Keynes called animal spirits. Only government can typically change the dynamic.
Could the government spending eventually lead to inflation and crippling debts? Absolutely. But the mistakes of the last 80 years have gone in the other direction. During the Great Depression, Japan’s lost decade, the Asian financial crisis and even the last 18 months, governments didn’t act aggressively enough. Deflation and lack of growth ended up being the real risks.
These are precisely the risks facing the world economy now. In Spain, prices are already falling. Layoffs are still mounting around the world. Financial firms have more losses to acknowledge.
Given the diminished standing of the United States, Mr. Obama won’t be able to get the Europeans to fall in line behind him this week. But he can still make progress. He and the American delegation can, in gentle terms, ask the Europeans to live up to their own standard " and remind them of their self-interest.
Two weeks ago, responding to criticism, an executive of the European Central Bank wrote a letter to an Italian newspaper claiming, “fiscal stimulus in European countries is wholly comparable to that seen in the United States.” That simply isn’t true, as the chart at right makes clear. The difference amounts to about $200 billion over three years.
Because the global economy is in many ways integrated, Europe can benefit from American stimulus without pulling its own weight. But because the global economy isn’t completely integrated, European stimulus would still help Europe more than anywhere else. And that presents the American delegation with perhaps its most persuasive case.
Right now, Eastern Europe appears to be one of the world’s most vulnerable places. It is a relatively poor region, where the population is disaffected and where the economy is shrinking rapidly. In both Estonia and Latvia, the gross domestic product fell 10 percent last year.
At the G-20, the leaders of the richer European countries will be asking the world to help Eastern Europe. By all means, the world should help. But Europe should reconsider its part, too.