What Economists Know and Do Not Know

(This piece appeared on the Boston Globe website on 2/2/09)

The House has passed an $819 billion spending package. Soon the Senate will vote. Will government spending get the economy going or slow it down? How long will it take to have an impact? How many jobs will it create? Can we afford it?

You would think economists could answer these questions. Since at least the Great Depression, economists have theorized about what causes the economy to slow down or speed up. We’ve theorized about unemployment and inflation and whether they’re connected. We’ve theorized about monetary policy, tax policy, and the role of government spending. And economists have tried to find evidence to settle these fundamental questions.

And yet there is little or no consensus for what we should do right now to get the economy going and prevent it from getting worse. I wish it were otherwise. People expect us to know the answers. And plenty of economists claim to have the answers. Yet some of the finest economists in the country, including Nobel laureates, are on opposite sides of the current debate. And each side can cherry-pick data or historical anecdotes in support of its position.

I think the real divide between economists isn’t over different macroeconomic theories but over underlying differences in philosophy and ideology. So where does that leave you, the curious, intelligent, non-economist citizen?

You could try to master the empirical evidence of each side. Perhaps one side is more persuasive than the other. Let me suggest a simpler strategy that gets at the underlying philosophic disagreement that I suspect is the heart of the matter.

Consider two different government programs for stimulating the economy. The first program borrows $819 billion and hires and pays groups of workers $819 billion to dig a bunch of holes and then fill them in. The second program spends $819 billion to repair a bunch of bridges on the verge of collapse, repair a bunch of sewers about to go bad, and revolutionize the energy and health sectors.

I think most economists would argue that the first program would be a bad use of federal money at a time when we’re already running a growing budget deficit. Yes, it would put money in the hands of workers but the effect on the non-hole-digging part of the economy would be insufficient to justify increasing the future taxes necessary to repay the borrowing that financed the program. Most economists would also agree that the second program would be a bargain that would yield benefits well beyond the money put in the hands of those executing the project.

I think the disagreement among economists is really over which of these two scenarios is closest to reality. The federal budget is about $3 trillion. Is the next $500 billion or so money well spent or money squandered?

I think it will be mostly squandered, so I’m against the stimulus. Plenty of people think it would be money well spent. Many people want a role for government closer to that of Europe’s. Most of us against increased government spending want to move in the other direction.

There is an underlying presumption in this debate that if the spending package doesn’t stimulate the economy, then tax cuts or monetary policy are better. But maybe we simply don’t have the knowledge to repair the economy from Washington. The economy is complex and the interaction between the financial sector and the real economy – between Wall Street and Main Street – is not well understood.

Rather than spending money we don’t have, I wish Obama would use his political capital to change the parts of our political system that are dysfunctional – our entitlement programs that are demographically bankrupt, our broken budget system, our Byzantine tax system, our financial system that is in disarray. These changes would be more likely to create the confidence and trust in the future that our economy needs to get healthy again rather than borrowing and spending. Borrowing and spending is how we got into this mess. Let’s look in a different direction.

Russell Roberts is professor of economics at George Mason University and a research fellow at Stanford’s Hoover Institution. He is the host of the weekly podcast EconTalk.

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