August 5, 2012, 6:11 p.m. ET
Arthur Laffer: The Real 'Stimulus' Record
In country after country, increased government spending acted more like a depressant than a stimulant.

It worked miserably, as indicated by the table nearby, which shows increases in government spending from 2007 to 2009 and subsequent changes in GDP growth rates. Of the 34 Organization for Economic Cooperation and Development nations, those with the largest spending spurts from 2007 to 2009 saw the least growth in GDP rates before and after the stimulus.

The four nationsEstonia, Ireland, the Slovak Republic and Finland—with the biggest stimulus programs had the steepest declines in growth. The United States was no different, with greater spending (up 7.3%) followed by far lower growth rates (down 8.4%).

Still, the debate rages between those who espouse stimulus spending as a remedy for our weak economy and those who argue it is the cause of our current malaise. The numbers at stake aren't small. Federal government spending as a share of GDP rose to a high of 27.3% in 2009 from 21.4% in late 2007. This increase is virtually all stimulus spending, including add-ons to the agricultural and housing bills in 2007, the $600 per capita tax rebate in 2008, the TARP and Fannie Mae and Freddie Mac bailouts, "cash for clunkers," additional mortgage relief subsidies and, of course, President Obama's $860 billion stimulus plan that promised to deliver unemployment rates below 6% by now. Stimulus spending over the past five years totaled more than $4 trillion.

If you believe, as I do, that the macro economy is the sum total of all of its micro parts, then stimulus spending really doesn't make much sense. In essence, it's when government takes additional resources beyond what it would otherwise take from one group of people (usually the people who produced the resources) and then gives those resources to another group of people (often to non-workers and non-producers).

Often as not, the qualification for receiving stimulus funds is the absence of work or income—such as banks and companies that fail, solar energy companies that can't make it on their own, unemployment benefits and the like. Quite simply, government taxing people more who work and then giving more money to people who don't work is a surefire recipe for less work, less output and more unemployment.

Yet the notion that additional spending is a "stimulus" and less spending is "austerity" is the norm just about everywhere.
Without ever thinking where the money comes from, politicians and many economists believe additional government spending adds to aggregate demand. You'd think that single-entry accounting were the God's truth and that, for the government at least, every check written has no offsetting debit.

Well, the truth is that government spending does come with debits. For every additional government dollar spent there is an additional private dollar taken.

All the stimulus to the spending recipients is matched on a dollar-for-dollar basis every minute of every day by a depressant placed on the people who pay for these transfers. Or as a student of the dismal science might say, the total income effects of additional government spending always sum to zero.

Meanwhile, what economists call the substitution or price effects of stimulus spending are negative for all parties. In other words, the transfer recipient has found a way to get paid without working, which makes not working more attractive, and the transfer payer gets paid less for working, again lowering incentives to work.
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But all of this is just old-timey price theory, the stuff that used to be taught in graduate economics departments. Today, even stimulus spending advocates have their Ph.D. defenders. But there's no arguing with the data in the nearby table, and the fact that greater stimulus spending was followed by lower growth rates.


Stimulus advocates have a lot of explaining to do. Their massive spending programs have hurt the economy and left us with huge bills to pay. Not a very nice combination.

Sorry, Keynesians. There was no discernible two or three dollar multiplier effect from every dollar the government spent and borrowed. In reality, every dollar of public-sector spending on stimulus simply wiped out a dollar of private investment and output, resulting in an overall decline in GDP. This is an even more astonishing result because government spending is counted in official GDP numbers. In other words, the spending was more like a valium for lethargic economies than a stimulant.

In many countries, an economic downturn, no matter how it's caused or the degree of change in the rate of growth, will trigger increases in public spending and therefore the appearance of a negative relationship between stimulus spending and economic growth. That is why the table focuses on changes in the rate of GDP growth, which helps isolate the effects of additional spending.

The evidence here is extremely damaging to the case made by Mr. Obama and others that there is economic value to spending more money on infrastructure, education, unemployment insurance, food stamps, windmills and bailouts. Mr. Obama keeps saying that if only Congress would pass his second stimulus plan, unemployment would finally start to fall. That's an expensive leap of faith with no evidence to confirm it.

Mr. Laffer, chairman of Laffer Associates and the Laffer Center for Supply-Side Economics, is co-author, with Stephen Moore, of "Return to Prosperity: How America Can Regain Its Economic Superpower Status" (Threshold, 2010).

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

Markets Insight
August 6, 2012 11:41 am

Draghi and friends just want your money
By Bill Gross

Psst! Investors – do you wanna know a secret? Do you wanna know what Angela Merkel, François Hollande, Christine Lagarde and Mario Draghi all share in common? They want your money!

They’ve wanted it for years now but you are resisting by holding on to it or investing it at negative interest rates in Switzerland, Germany and a growing number of other countries considered to be European Union havens. They want you to be less frugal and more risk-seeking. They want your money as a substitute for theirs in Spain, Italy and, of course, Greece, but they don’t mention that any more. The example would be too off-putting. “Investors,” they plead, “show us your money!”

The ultimate goal of monetary and fiscal policy in the EU is to re-engage the private sector. The EU needs the private sector as a willing (but not necessarily equal) partner in funding its economy. This often gets lost in the noisy details of all too frequent promises such as the one to defend the euro made by Mr Draghi, European Central Bank president.

Investors get distracted by the hundreds of billions of euros in sovereign policy checks, promises and IOUs that make for media headlines but forget it’s their trillions that are the real objective. Even Mr Hollande in left-leaning France recognises that the private sector is critical for future growth in the EU. He knows that, without its partnership, a one-sided funding via state-controlled banks and central banks will inevitably lead to high debt-to-GDP ratios, rating service downgrades and a downhill vicious cycle of recession.

But private investors are balking – and for what it seems are good reasons – because policy makers’ efforts have been, until now, a day late and a euro short, or more accurately, years late and a trillion euros short. Let’s look at some examples of this.

First, Greek bailouts that included private sector involvement but no official sector involvement, resulting in the inevitable investor conclusion that future programmes for Spain and Italy might resemble the same.

Second, an initial tightening and then a reluctant lowering of ECB policy rates.

Third, a bond purchase programme (securities markets programme or SMP) by the ECB that was too small and prematurely abandoned.

Fourth, fiscal austerity packages for individual countries that accelerated recessionary/depressionary growth paths.

Fifth, public fights among northern and southern EU countries that highlighted the seemingly perpetual dysfunctionality of the eurozone 17 and the EU 27.

Finally, Mr Draghi’s reversal last Thursday. Someone must have got to him between London and Frankfurt.

Policy makers now face an unprecedented expansion of risk spreads and credit agency downgrades which almost guarantee that sickbed countries can never be discharged from intensive care.

Investors misguidedly focus on 7 per cent yields in Spanish and Italian bond markets as some sort of high watermarkbelow which swimmers can safely touch bottom. But even at 7 per cent deep, the toes cannot stretch. Maybe even 4 per cent is not shallow enough.

Interest rates over and above each country’s nominal GDP growth rate will inevitably add to a country’s debt as a percentage of GDP, even if budgets are in primary balance.

At current yields, growth rates, and deficits, the spread may incrementally add 2-3 per cent to Spain and Italy’s tenuous debt ratios every year. While it is true that both countries can shorten maturity offerings and even accept the benefit of prior terming of their debt stock, eventual drowning will occur even at 4 per cent or higher 10-year yields as long as nominal GDP growth is anywhere close to flat.

Policy makers will solicit the private market’s participation in an effort to get there, by attempting to lead via co-ordinated monetary/fiscal efforts involving the SMP from the ECB and hundreds of billions of euros from bailout funds – the European Financial Stability Facility and ultimately the European Stability Mechanism. But without the private sector’s co-operation, the effort may be futile.

The dirty little secret that sovereign debt issuing nations need to remember most of all is that credit and maturity extension is based upon trust. After all, “credere” is a Latin word meaning just that.

After trust has been lost due to half-baked policy measures; after credit agencies belatedly have recognised embedded costs of debt that can no longer insure solvency; after marginal investors have been flushed from the system to what appear to be safer return of principal havens; and after policy makers finally appreciate the fragility of their rigged fiscal and monetary system; after all of that – there is no coming home, there is no going back in the water.

Psst investors: Stay dry my friends!

Bill Gross is founder and co-chief investment officer of Pimco

Copyright The Financial Times Limited 2012.

From Resource Curse to Blessing

Joseph E. Stiglitz

06 August 2012

KAMPALANew discoveries of natural resources in several African countries – including Ghana, Uganda, Tanzania, and Mozambique raise an important question: Will these windfalls be a blessing that brings prosperity and hope, or a political and economic curse, as has been the case in so many countries?

On average, resource-rich countries have done even more poorly than countries without resources. They have grown more slowly, and with greater inequalityjust the opposite of what one would expect. After all, taxing natural resources at high rates will not cause them to disappear, which means that countries whose major source of revenue is natural resources can use them to finance education, health care, development, and redistribution.

A large literature in economics and political science has developed to explain this “resource curse,”and civil-society groups (such as Revenue Watch and the Extractive Industries Transparency Initiative) have been established to try to counter it.

Three of the curse’s economic ingredients are well known:

  • Resource-rich countries tend to have strong currencies, which impede other exports;

  • Because resource extraction often entails little job creation, unemployment rises;

  • Volatile resource prices cause growth to be unstable, aided by international banks that rush in when commodity prices are high and rush out in the downturns (reflecting the time-honored principle that bankers lend only to those who do not need their money).

Moreover, resource-rich countries often do not pursue sustainable growth strategies. They fail to recognize that if they do not reinvest their resource wealth into productive investments above ground, they are actually becoming poorer. Political dysfunction exacerbates the problem, as conflict over access to resource rents gives rise to corrupt and undemocratic governments.

There are well known antidotes to each of these problems: a low exchange rate, a stabilization fund, careful investment of resource revenues (including in the country’s people), a ban on borrowing, and transparency (so citizens can at least see the money coming in and going out). But there is a growing consensus that these measures, while necessary, are insufficient. Newly enriched countries need to take several more steps in order to increase the likelihood of a “resource blessing.”

First, these countries must do more to ensure that their citizens get the full value of the resources. There is an unavoidable conflict of interest between (usually foreign) natural-resource companies and host countries: the former want to minimize what they pay, while the latter need to maximize it. Well designed, competitive, transparent auctions can generate much more revenue than sweetheart deals. Contracts, too, should be transparent, and should ensure that if prices soar – as they have repeatedly – the windfall gain does not go only to the company.

Unfortunately, many countries have already signed bad contracts that give a disproportionate share of the resources’ value to private foreign companies. But there is a simple answer: renegotiate; if that is impossible, impose a windfall-profit tax.

All over the world, countries have been doing this. Of course, natural-resource companies will push back, emphasize the sanctity of contracts, and threaten to leave. But the outcome is typically otherwise. A fair renegotiation can be the basis of a better long-term relationship.

Botswana's renegotiations of such contracts laid the foundations of its remarkable growth for the last four decades. Moreover, it is not only developing countries, such as Bolivia and Venezuela, that renegotiate; developed countries like Israel and Australia have done so as well. Even the United States has imposed a windfall-profits tax.

Equally important, the money gained through natural resources must be used to promote development. The old colonial powers regarded Africa simply as a place from which to extract resources. Some of the new purchasers have a similar attitude.

Infrastructure (roads, railroads, and ports) has been built with one goal in mind: getting the resources out of the country at as low a price as possible, with no effort to process the resources in the country, let alone to develop local industries based on them.

Real development requires exploring all possible linkages: training local workers, developing small and medium-size enterprises to provide inputs for mining operations and oil and gas companies, domestic processing, and integrating the natural resources into the country’s economic structure. Of course, today, these countries may not have a comparative advantage in many of these activities, and some will argue that countries should stick to their strengths. From this perspective, these countries’ comparative advantage is having other countries exploit their resources.

That is wrong. What matters is dynamic comparative advantage, or comparative advantage in the long run, which can be shaped. Forty years ago, South Korea had a comparative advantage in growing rice. Had it stuck to that strength, it would not be the industrial giant that it is today. It might be the world’s most efficient rice grower, but it would still be poor.

Companies will tell Ghana, Uganda, Tanzania, and Mozambique to act quickly, but there is good reason for them to move more deliberately. The resources will not disappear, and commodity prices have been rising. In the meantime, these countries can put in place the institutions, policies, and laws needed to ensure that the resources benefit all of their citizens.

Resources should be a blessing, not a curse. They can be, but it will not happen on its own. And it will not happen easily.

Joseph E. Stiglitz, a Nobel laureate in economics, has pioneered pathbreaking theories in the fields of economic information, taxation, development, trade, and technical change. As a policymaker, he served on and later chaired President Bill Clinton’s Council of Economic Advisers, and was Senior Vice President and Chief Economist of the World Bank. He is currently a professor at Columbia University, and has taught at Stanford, Yale, Princeton, and Oxford.He is the author of The Price of Inequality: How Today’s Divided Society Endangers our Future.

August 6, 2012 7:03 pm
The backlash against the rich has gone global
By Gideon Rachman

Ingram Pinn illustration©Ingram Pinn

It is never a great sign when politicians start appealing to taxpayers’ patriotism. Defending the French government’s recent decision to raise the top rate of income tax to 75 per cent, Pierre Moscovici, the country’s finance minister, told Le Monde: “This is not a punitive measure, but a patriotic measure.” The rich, he explained, are being given an opportunity to make “an exceptional contribution” to solving France’s financial problems. I am sure they are very grateful.

France is clearly taking a big risk by raising its tax rates so much higher than those of its neighbours. But it is a mistake to portray the Hollande administration as Socialist dinosaurs. The truth is that the new French government is at the extreme end of a new global trend: an international backlash against the wealthy that is reshaping politics from Europe to the US to China.

David Cameron, the British prime minister, has offered to roll out the red carpet for French tax exiles. But even in Britain, where the top tax rate is 45 per cent, there is a new mood of antagonism towards the rich. Even conservative politicians dare not defend bankers’ pay.

In the US, meanwhile, Barack Obama is campaigning to increase taxes on “millionaires and billionaires”. It is true that the tax rises that the US president wants would be laughably small by French standards. Mr Obama merely wants to raise the top rate from 35 per cent to 39.6 per cent, as well as increasing taxes on capital gains and dividends.

But some of the president’s rhetoric has distinct echoes of the successful Hollande campaign in France. The French socialists made great play of Nicolas Sarkozy’s allegedlyblinglifestyle and friendships with the super-rich. In similar vein, the Obama campaign has attacked Mitt Romney as a tax-dodging representative of “the 1 per cent” – and mocked his wife’s ownership of a dressage horse.

These tactics sound risky because Americans are traditionally said to admire the wealthy, rather than to envy them. But the Obama camp can read polls. By a margin of 64 per cent to 33 per cent, Americans are in favour of higher taxes on those earning more than $250,000.

Political sensitivities about the gap between the wealthy and the rest are not confined to the west. The lifestyles of the rich and powerful is now the most sensitive and dangerous topic in Chinese politics.

The website of Bloomberg News was recently shut down in China, apparently as punishment for the publication of an article on the family wealth of Xi Jinping, soon to be China’s new president.

In one incident a couple of weeks ago, riots over pollution in the city of Qindong took a nasty turn when demonstrators demanded to know what brand of clothing the local party secretary was wearing.

The BBC reports: “On discovering it was an expensive Italian brand, they are said to have stripped him to the waist.”

Why is all this happening? As Zanny Minton Beddoes of The Economist writes in a recent essay, “a majority of the world’s citizens now live in countries where the gap between the rich and the rest is a lot bigger than it was a generation ago”. The trend has been most extreme in the west. As Ms Minton Beddoes points out, in the US “the portion of national income going to the richest 1 per cent tripled from 8 per cent in the 1970s to 24 per cent in 2007”.

Eventually that kind of shift is liable to spark a political backlash. The trigger for that reaction has been the Great Recession, which has increased the pressure on the living standards of ordinary people, while exposing misbehaviour at the top. Western politicians, from Barack Obama to François Hollande are seeking to capture and channel this new mood.

In Asia, where the Great Recession has hit less hard, other factors may be at work. The internet and the rise of microblogging have made it easier to spread information and to whip up indignation about the gap between the hard-pressed worker and the super-rich.

If this new mood hardens, it could mark the end of an era of lower taxes, deregulation and rising inequality that began in the late 1970s, with the rise of Margaret Thatcher and Ronald Reagan in the west and of Deng Xiaoping in China. When Lady Thatcher came to office in 1979, Britain’s top tax rate was 83 per cent. She cut it, first to 60 per cent and then to 40 per cent – where it stayed until the financial crisis. Reagan inherited a top income tax rate of 70 per cent and cut it to 50 per cent and finally to 28 per cent. In China, Deng Xiaoping captured the spirit of the times when he remarked: “To get rich is glorious.”

Now a new global mood has taken hold. In China, political leaders have eschewed the frank celebration of wealth. In the western world, cash-strapped politicians are eager to raise taxes on the newly unpopular rich.

The big question is whether this is still possible in a globalised world. As Mr Cameron’s tactless remarks about red carpets have underlined, any government that raises taxes too far and fast is in danger of sparking a flight of capital and business. The super-rich are mobile and well-advised.

The merely well-off, however, are likely to find it harder to evade a new push for higher taxes across the west. James Callaghan, the prime minister Mrs Thatcher defeated in 1979, remarked perceptively: “There are times, perhaps once every 30 years, when there is a sea change in politics.” Roughly 30 years after the beginning of the Thatcher-Reagan era, another sea change is upon us.

Copyright The Financial Times Limited 2012.