BALI, Indonesia — In response to the current financial and economic turmoil, U.S. politicians wanted to be seen as “doing something” legislatively, even if costly and ineffective, in order to endear themselves to those voters who received benefits. This is evident in that the “stimulus spending” provides more political gains for special interests than economic gains to the country as a whole.

Meanwhile, political leaders around the world are following this lead, falling over each other trying to put together similar spending packages. Taxpayers of the world, look out. You have only your money and future to lose!

Unfortunately, politicians misunderstand the cause of the preceding boom that set the stage for the inevitable recession now upon us. Hoping for short- term political payoffs, they care not that their initiatives will not halt the inevitable adjustments that will have to occur after the bubbles to restore economic sanity.

Indeed, the current policy response is similar to the course taken by the Hoover and Roosevelt administrations (1930s) that helped turn a recession into the Great Depression. Then, as now, interfering with market adjustment processes delayed the inevitable while worsening the economic downturn.

Today, politicians cravenly use fear of impending economic doom to sway public opinion by comparing the turmoil with the Great Depression. Yet, the current recession is more like the economic contractions of 1973 or 1981.

As for 1929, the decline in economic output finished 4.7 times greater, and unemployment went much higher, than they did in 2008.

A better comparison is with the mess overseen by President Jimmy Carter. During June 1980, the combined unemployment and inflation rates, known as the “misery index,” hit 22 percent. During the single term that Carter held office, America experienced double-digit inflation, double-digit unemployment, double-digit interest rates, shrinking incomes and increasing poverty. As the Federal Reserve raised the federal-funds rate from 9 percent in July 1980 to 19.1 percent, the 30-year mortgage rate hit 18.45 percent.

Once again the laws of men are being implemented to supersede economic laws that require much price and wage adjustment during a recession so that markets can clear. This clearing serves the best interests of the overall community by enabling unemployed labor and misused capital assets to be put to productive and profitable use. Only then can there be a sustainable economic recovery.

A critical flaw in the thinking of most policymakers relates to labor markets. Maintaining money wage rates and housing prices that were pushed up to unsustainable levels during an artificial boom will lead to persistent and widespread unemployment.

In the end, the counter-intuitive conclusion is that the best antidote for unemployment is that wage rates must fall. For the housing market, housing prices must adjust to the new realities.

Allowing wages and asset prices to fall is neither “tough love” nor a heartless application of a Darwinian survival principle. History shows that the most effective and humane response to economic downturns is for governments to refrain from interfering with asset deleveraging and the shedding of labor.

In any case, most workers given a choice between lower wages and losing a job might prefer a wage cut, which may mean that the rate of increase in wages is lower than the rate of increase in prices.

As it is, the so-called stimulus package will eventually reduce the purchasing power of wages, albeit it in a less direct manner. Flooding the banking system with newly created paper money and credit will eventually lead to a surge in price levels and a run on the dollar that will cut purchasing power.

With the monetary base in the United States up 107 percent from Aug. 8, 2008, to Jan. 9, 2009, and the money supply increasing by 40 percent over the last six months of 2008, a future recovery will almost certainly be accompanied by surging price levels. With or without the stimulus packages, workers will be forced to confront a loss in purchasing power. Our politicians hope to buy support by deferring the inevitable.

When other solutions failed to cut unemployment rates during the Great Depression, President Franklin D. Roosevelt invoked military conscription. This “solved” the problem by having the unemployed masses do butchers’ work in a global war at low-wage rates. Much suffering, and perhaps the eventuality of war, might have been avoided if wage rates had declined under the pressure of market forces at the outset of the recession.

The political urge to spend to “stimulate” the economy is also being driven by an apparent consensus that governments must spend more to end the economic doldrums. This notion continues despite robust logical, theoretical and historical challenges.

Logically, if massive increases in government spending can bring prosperity, then it follows that large cuts should cause widespread economic misery. But consider what happened when sharp reductions in public-sector spending occurred after World War II. Between 1945 and 1947, the U.S. government slashed annual federal spending from $95 billion to $36 billion, for a reduction of 62 percent.

If government spending “multipliers” worked as advertised, the U.S. economy should have collapsed from such a sharp drop. It turns out that an expansionary effect from changing expectations about future burdens of taxation and government interventions inspired higher consumption and investment. The U.S. economy then began the longest period of growth and prosperity in its history, which suggests that the best long-term economic stimulus is less government spending, not more.

Christopher Lingle is a research scholar at the Center for Civil Society in New Delhi and visiting professor of economics at Universidad Francisco Marroquin, Guatemala. E-mail: CLingle@ufm.edu

In a time of both misinformation and too much information, quality journalism is more crucial than ever.
By subscribing, you can help us get the story right.