Economists of all political stripes are scrambling to come up with plans to stimulate the economy. Both Congress and the Bush administration are desperate to come up with something to get the economy off its back. And it seems certain that something will be done. The question is what, and will the cure be worse than the disease?
Thus far, we have mostly seen renewed emphasis on proposals that were kicking around well before Sept.11. These include a cut in the capital gains tax, a cut in the corporate tax rate and a cut in payroll taxes. Of course, on the spending side, every industry looking for special favors is wearing its connection to national defense, no matter how tenuous, like the medals on old soldiers in a Veterans Day parade.
With the Social Security lockbox out the window, there is suddenly plenty of money for everyone's pet programs. And with our nation under foreign attack for the first time in 60 years, and the economy prostrate, what congressman or senator is going to be brave enough to vote against economic stimulus or national security?
This is the way it went back in 1942, as well. Money was thrown left and right at anything with a national security connection. The feeling, perhaps not unjustified under the circumstances, was that it was better to waste a bit of money because time was too short for thorough study and review. Later, when there was more time, Congress would try to fix the mess it created. Harry Truman, then a senator from Missouri, essentially made his reputation studying wasteful defense programs in the aftermath of the spending spree.
Today, there are those who want to repeat the mistakes of 1942 under completely different circumstances. Then, America was faced with a two-front war against very powerful enemies, and the war required unprecedented numbers of fighting men and vast quantities of arms and military equipment. The war against terrorism will not require new army divisions, thousands of tanks and the like, as World War II did. It will be a war fought primarily by the intelligence services and a relatively small number of pilots and special forces units.
In short, this war will not require massive mobilization. It will not even require that much in the way of additional resources for the Defense Department. It will require a significant change in strategy and a resolve that America has not displayed for some time to use our military might effectively. President Bush's speech to Congress made this abundantly clear. The question is whether the American people will maintain their resolve as the months, and perhaps years, go by without the kind of open battles and definitive victories they have come to expect in war.
In terms of the economy, we must also be prepared to target stimulus to the nature of the problem. That may mean that the methods used to fight past economic wars will also have to change.
One problem I see is that economic theories designed for different purposes are being brought to bear on problems for which they may be ill-suited. A reduction in the cost of capital, either through a cut in corporate taxes or the capital gains tax, will unquestionably promote higher long-term growth. But I have serious doubts as to whether either of these measures will provide any short-run stimulus to the economy. How will it help the stock market to encourage the sale of assets that have appreciated in value? And how can cutting the corporate tax help companies without profits to pay taxes on?
Like it or not, Keynesian economic theories are better suited to short-run stimulus. The problem is that they do nothing to encourage long-term growth and can even depress it by raising inflation. But here again there is a disconnect. Increasing consumer demand, through tax rebates or temporary cuts in the payroll tax, might help if consumers lacked purchasing power. But that is not the case. Consumers as a whole are generally well off. They are not refusing to spend because they lack funds, but because they lack confidence.
At the risk of sounding like a Pollyanna, I continue to believe that the economy is fundamentally sound and not in need of additional short-run stimulus. Those proposals being bandied about appear ill-targeted to the economy's real problem, probably won't have any impact until the economy has recovered on its own and may have a negative impact in the longer run.
What the economy desperately needs is not anything Congress can enact. It is a restoration of confidence that the American way of life will go on. I believe it will, but in the near term people will need time to get their heads together before life goes on again. The best thing our leaders can do is remain calm and not overreact, do what has to be done to clean up the damage and prosecute the war, and give the American people time to recover from a grievous assault on their consciousness.