The Bridge to Economic Nowhere

by Fred E. Foldvary, Senior Editor, The Progress Report November 2008

President-elect Obama’s plan for a massive national public works project will fail to revive the economy. Such works did not end the Great Depression, and they did not revive the Japanese economy during the stagnant 1990s. Most such projects also take time to plan and implement, so they will not provide quick relief. The way to quickly end the recession is to give every U.S. resident several thousand dollars in cash. Since a cash distribution is not being done, ineffective public works are not primarily a way to end the recession, but a political payback to special interests. The “market for legislation” will allocate which regions and corporations and unions get the handouts. Public works are a bridge to economic nowhere.

A program of public works such as repairing bridges sounds like it would create jobs, if one does not understand economics. If you do understand economics, you will recognize this as the broken window fallacy. The French economist Bastiat wrote a satire in which shop windows get broken, and people see the labor involved in repairing them, and they then think that the way to create jobs is to break windows. It is a fallacy because if the windows had not been broken, the jobs and resources would have been devoted to something else. The same illogic applies to creating jobs with public works.

Public works crowd out the private works that would otherwise have been provided. Some jobs are created if there were unemployed carpenters and engineers who get jobs in the program, but mostly such works pull away workers from projects that would have been built by private enterprise or would have been done by local governments. Public works also crowd out private finance. People who would have lent funds or bought stock in private firms instead buy government bonds. That raises interest rates and reduces private investment.

The Obama public works will have to be financed by ever more borrowing, which will add to the already bloated federal government debt, and speed the day when U.S. treasury debt will no longer be considered super safe. Public works, once started, become long-term projects which continue after the economy has revived, and which then continue to suck off resources and funding, weakening rather than strengthening the recovery.

Of course one justification for public works is that bridges, highways, and old buildings are crumbling from insufficient past maintenance and repair. If a bridge needs to be repaired, then of course that may well be the best use of resources. The only proper justification for governmental public works is that the investment is more productive than alternatives. In that case, the resources do not crowd out alternatives, because the works make the economy more productive in the long run.

If a bridge truly needs repair, then do it. But don’t build pyramids just for the sake of jobs. The way to quickly revive the economy is to stimulate general demand, not specific demand. Government distorts the economy when it artificially stimulates particular parts of the economy at the expense of other parts. Aside from creating perverse political incentives and corruption, the government lacks the knowledge of which parts of the economy to boost.

Government chiefs are inconsistent when they claim to want to stimulate the economy, yet they increase the barriers that crush investment and enterprise. The coming administration seeks sharply higher taxes on wealthy investors. They want to eliminate the cap on payroll taxes, which would add 15 percent to the tax rate. They also want to let the tax cuts of the early decade expire, which would add more to the marginal tax rate, the tax on extra income. The combined federal, payroll, and typical state income tax rate would be about two-thirds of extra income.

If government chiefs really seek to stop the financial waterfall and economic plunge, they would do the opposite: reduce marginal income tax rates. Push the economy towards revival with by removing the land value subsidy that led to the Crash of 2008. The economy would jump start if the government replaced taxes on labor and investment returns with taxes on pollution and land value.

A direct tax on the value of land, paid by the states in proportion to their populations, is Constitutional and was applied several times prior to the Civil War. It could be enacted as an emergency tax shift. But it won’t, because the public is not demanding it. Instead, folks believe in breaking windows. When will they learn that public works are a bridge to economic nowhere?

— Fred Foldvary

 

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