Thursday, December 1, 2011

Demand Be Damned

It looks like a good bet that unemployment benefits in the U.S. will be extended again. It’s a move that’s hard to be against, although the political parties have tussled over how or whether the extension will be paid for.

There are many positive things to say about extending unemployment benefits for people who have exhausted their standard entitlement. It is compassionate and even generous. There are people whose lives will be made at least a bit easier by this government expenditure.

But it’s a bit of a leap to say, as many politicians and even a few reporters have, that the extension actually helps the overall economy. They reason that putting more money in the hands of people is a stimulus because those people will go out and spend it. But, if you follow this assertion to its logical conclusion, what they are essentially saying is that you can put people back to work by paying them not to work. The fact is that history has shown that there is always a marked downturn in the unemployment rate when the government stops authorizing unemployment benefit extensions. While those payments are a lifesaver for many, there are also a lot of people who wait until the payments stop before they get serious about finding a new job.

The problem is that pointing out this fact makes one seem rather heartless. One sounds as though one is blaming the victim. Rather than argue over whether unemployment benefits should be extended, it would be better if there were enough jobs for everyone who wants one—and even for those who don’t want one. But the fuzzy thinking exhibited by people who say that extending unemployment payments actually helps the economy illustrates why governments find themselves in patterns that actually make the economy worse.

The notion of the government putting money in the hands of people to stimulate the economy is what is called demand-side economics. If the economy isn’t doing well, according to this view, it’s because people aren’t spending enough. The opposite approach is supply-side economics. That’s where the government increases incentives for people to work (i.e. to start or expand a business), generally through lower taxes or other government-related costs. During the good economic times of the Reagan presidency, critics derided supply-side economics by calling it trickle-down economics. But after the past couple years of demand-side policy, I think more than a few people would be happy to have been getting some trickle-down.

In a way, the economy is like a dog chasing its tail, with supply and demand alternating in a constant loop. Does it make a difference whether the government helps on the supply side or on the demand side? When you think about it, the two approaches reflect two very different ways of viewing the economy, society and our culture. One encourages people to produce something, i.e. make things or perform services. The other encourages people to be consumers, to go shopping. If you are producing something, you will likely get paid for it and become a consumer as a natural result. But when you try to get the economy going by encouraging people to consume, the problem is that the products and services that people want to consume may not necessarily be in supply. It is easier for a worker to also be a shopper than for a shopper to also be a worker.

When the government puts money directly in the hands of citizens, it may result in genuine short-term benefit and make politicians popular and ordinary taxpayers feel good but, as we have seen over the past couple of years, it doesn’t necessarily translate into lower unemployment. In fact, a large government spending spree (combined with increased economic uncertainty spurred by new massive programs like Obamacare and more complex regulations) turns out to be a disincentive for people to start or expand businesses.

That is why the sharp economic drop in 2008—which history suggests should have been followed by a similarly steep recovery—was followed by one of the weakest recoveries seen in modern times. This experience should put the final nail in the coffin of Keynesian economics, but it won’t. There’s just too much fuzzy thinking out there.