Wednesday, September 16, 2009

The Stimulus Didn't Work - The data show government transfers and rebates have not increased consumption at all

The data show government transfers and rebates have not increased consumption at all.
The Wall Street Journal, page A23

Is the American Recovery and Reinvestment Act of 2009 working? At the time of the act's passage last February, this question was hotly debated. Administration economists cited Keynesian models that predicted that the $787 billion stimulus package would increase GDP by enough to create 3.6 million jobs. Our own research showed that more modern macroeconomic models predicted only one-sixth of that GDP impact. Estimates by economist Robert Barro of Harvard predicted the impact would not be significantly different from zero.

Now, six months after the act's passage, we no longer have to rely solely on the predictions of models. We can look and see what actually happened.

Consider first the part of the package that consists of government transfers and rebates. These include one-time payments of $250 to eligible individuals receiving Social Security, Supplemental Security Income, veterans benefits or railroad retirement benefits and temporary reductions in income-tax withholding for a refundable tax credit of up to $400 for individuals and $800 for families with incomes below certain thresholds. These payments, which began in March of this year, were intended to increase consumption that would help jump-start the economy. Now that a good fraction of these actions have taken place, we can assess their impact.

The nearby chart [] reviews income and consumption through July, the latest month this data is available for the U.S. economy as a whole.

Consider first the part of the chart pertaining to the spring of this year and observe that disposable personal income (DPI) the total amount of income people have left to spend after they pay taxes and receive transfers from the government jumped. The increase is due to the transfer and rebate payments in the 2009 stimulus package. However, as the chart also shows, there was no noticeable impact on personal consumption expenditures. Because the boost to income is temporary, at best only a very small fraction was consumed.

This is exactly what one would expect from "permanent income" or "life-cycle" theories of consumption, which argue that temporary changes in income have little effect on consumption. These theories were developed by Milton Friedman and Franco Modigliani 50 years ago, and have been empirically tested many times. They are much more accurate than simple Keynesian theories of consumption, so the lack of an impact should not be surprising.

Indeed, one need not have looked any further than the Bush administration's Economic Stimulus Act of 2008 to find plenty of evidence that temporary payments of this kind would not jump-start consumption. That package made one-time payments and rebates to people in the spring of 2008, but, as the chart shows, failed to stimulate consumption as had been hoped. Some argued that other factors such as high oil and gasoline prices caused consumption to fall during this period and that consumption would have been even lower without the stimulus, but no significant impact of these rebates is found even after controlling for oil prices.

Consider next the government-spending part of the stimulus package. The Obama administration points to the sharp reduction in the decline in real GDP from the first to the second quarter of 2009 as evidence that the package is working. Economic growth was minus 6.4% in the first quarter and minus 1% in the second quarter, so the implied improvement of 5.4 percentage points is indeed big. But how much of that improved growth rate can be attributed to higher government spending due to the stimulus? If we rely on predictions of models, again we see disagreement and debate. According to our research with modern macroeconomic models, the increase in government spending would add less than a percentage point, a relatively small portion. The model predictions cited by the administration's economists suggest a much larger portion: two to three percentage points. Prof. Barro's model predicts zero.

So let's look at the data on the contributions of government spending and other components of GDP to the 5.4 percentage-point improvement. By far the largest positive contributor to the improvement was investment which went from minus 9% to minus 3.2%, an improvement of 5.8% and more than enough to explain the improved GDP growth. Investment by private business firms in plant, equipment and inventories, rather than residential investment, were the major contributors to the investment improvement. In contrast, consumption was a negative contributor to the change in GDP growth, because consumption growth declined following the passage of the stimulus package.

One is hard put to see what specific items in the stimulus act could have arrested the decline in business investment by such a magnitude. When one looks at monthly investment indicators such as new orders for nondefense capital goods one sees a flattening out starting early in the first quarter of 2009, well before the package went into operation. The free fall of investment orders caused by the financial panic last fall stabilized substantially by January, and investment has remained relatively stable since then. This created the residue of a very large negative growth rate from the fourth quarter of 2008 to the first quarter of 2009, and then moderation from the first quarter to the second of 2009. There is no plausible role for the fiscal stimulus here.

Direct evidence of an impact by government spending can be found in 1.8 of the 5.4 percentage-point improvement from the first to second quarter of this year. However, more than half of this contribution was due to defense spending that was not part of the stimulus package. Of the entire $787 billion stimulus package, only $4.5 billion went to federal purchases and $17.7 billion to state and local purchases in the second quarter. The growth improvement in the second quarter must have been largely due to factors other than the stimulus package.

Incoming data will reveal more in coming months, but the data available so far tell us that the government transfers and rebates have not stimulated consumption at all, and that the resilience of the private sector following the fall 2008 panic not the fiscal stimulus program deserves the lion's share of the credit for the impressive growth improvement from the first to the second quarter. As the economic recovery takes hold, it is important to continue assessing the role played by the stimulus package and other factors. These assessments can be a valuable guide to future policy makers in designing effective policy responses to economic downturns.

Mr. Cogan, a senior fellow at the Hoover Institution, was deputy director of the Office of Management and Budget under President Ronald Reagan. Mr. Taylor, an economics professor at Stanford and a Hoover senior fellow, is the author of "Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis" (Hoover Press, 2009). Mr. Wieland is a professor of monetary theory at Goethe University in Frankfurt, Germany.

Massachusetts Is a Health-Reform Model - it insures 97% of state residents

Massachusetts Is a Health-Reform Model. By DEVAL L. PATRICK
Our system insures 97% of state residents.
WSJ, Sep 17, 2009

Our country now faces the best opportunity in decades to provide quality health care for all Americans while containing spiraling costs. My state, Massachusetts, can serve as a model for national reform.

The case for country-wide change is clear. The health-care system in America costs us too much for what we get. Rising health-care costs are hurting families working hard to make ends meet and businesses trying to compete and create jobs. Too many people face financial disaster when they get sick because their insurance is inadequate or their coverage is dropped. Other Americans get their primary care during expensive visits to the emergency room because they have no other option. These costs affect all of us; everyone has a stake in health-care reform.

When we in Massachusetts set out to change our system, some were afraid. People almost always fear change, and politicians sometimes seize on that fear to prevent it. But in an act of political courage, a Democratic senator, a Republican governor and a Democratic state legislature formed a broad coalition with health-care providers, medical experts, business and labor leaders and patient advocates to fundamentally reform our system. And we have maintained our coalition as we've moved forward. After many years of widespread dissatisfaction with the old health-care system, we realized that a perfect solution or the status quo were not our only choices.

Because of our reform, over 97% of Massachusetts residents are insured the highest rate of coverage of any state in the nation. Our residents now have better access to preventive care in lower cost primary-care settings. Employers have expanded coverage for workers, not retreated as some feared. Families are less likely to be forced into bankruptcy by medical costs. Most importantly, lives have been saved. This is all good news for our residents, as well as for our state's long-term economic prosperity.

Opponents of reform claim that the Massachusetts experiment is too costly. They are wrong. State estimates and independent analysis from the Massachusetts Taxpayers Foundation concur that health-care reform has only added moderate incremental costs to the state budget. As more of our residents have become insured, there has been a decrease in demand for costly emergency-room care. Even in the midst of the current economic downturn, our state budget was balanced.

But the real issue is not the incremental costs of expanding coverage. It's the fact that medical costs even for those who have always had insurance are rising too fast.

Massachusetts is poised to lead the nation in addressing this problem, too. A special state commission has unanimously recommended moving away from the "fee for service" practice that drives up costs and fragments care, and replacing it with an alternative payment strategy designed to reward doctors and hospitals for providing coordinated care that achieves the best health outcomes for patients and lowers costs. As we work to translate this vision into practice, health care in the state will just get better.

We are proud of our success in Massachusetts. But we are also deeply committed to supporting federal health-care reform that will tackle costs and establish important patient protections to guard against some of the worst insurance-industry practices, including exorbitant out-of-pocket expenses, co-pays and deductibles that drive many families into bankruptcy. Working families and businesses have been waiting too long for relief.

Tough economic times are no excuse for more delay. Massachusetts is required by law to pass a balanced budget, and the recession has meant that we face the same kinds of financial strains as the critics of national reform. But changing our health-care system is essential to improving our economy. The current economic crisis only underscores the need to push ahead with reform.

At the national level, nothing will happen if we fear change. But innovation can work for everyone if we give President Barack Obama and congressional leaders a chance to do what we have done in Massachusetts.

Mr. Patrick, a Democrat, is the governor of Massachusetts.

WSJ Editorial: Obama and the cost of individual insurance

Another Health-Care Invention. WSJ Editorial
Obama and the cost of individual insurance.
The Wall Street Journal, page A26, Sep 16, 2009

Speaking of health-care distortions, as President Obama likes to do, consider his assertion to Congress that "buying insurance on your own costs you three times as much as the coverage you get from your employer." He liked that one so much that he repeated it over the weekend in Minneapolis, this time as a swipe at "the marketplace."

The media's "fact-check" brigade hasn't noticed, but this is simply false. The Congressional Budget Office expects premiums for employer-sponsored coverage to cost about $5,000 for singles and $13,000 for families this year on average. "Premiums for policies purchased in the individual market," adds CBO, "are much lower—about one-third lower for single coverage and half that level for family policies."

Similarly, the federal Agency for Healthcare Research and Quality finds that the growth rate for premiums is also lower for individuals over employers. Mr. Obama's health team surely knows this dynamic, given that the CBO report was issued under the auspices of Peter Orszag, now the White House budget director.

One reason that individual policies are cheaper is that they generally require more cost-sharing by consumers. The reason that employment-based plans seem cheaper is that on average workers only pay 17% of the premiums directly if they're single, and 27% for family policies, according to the Kaiser Family Foundation. Businesses pick up the rest by paying lower wages, thus hiding the real costs. Meanwhile, in the individual market, consumers pay with after-tax dollars because Democrats won't allow individuals to have the same tax subsidy that employer policies receive.

This tax differential is the core of "our inefficient and inequitable system of tax-advantaged, employer-based health insurance," writes Jeffrey Flier, the dean of Harvard Medical School, in a new commentary in the Journal of Clinical Investigation.

"While the federal tax code promotes overspending by making the majority unaware of the true cost of their insurance and care," he writes, "the code is grossly unfair to the self-employed, small businesses, workers who stick with a bad job because they need the coverage, and workers who lose their jobs after getting sick. . . . How this developed and persisted despite its unfairness and maladaptive consequences is a powerful illustration of the law of unintended consequences and the fact that government can take six decades or more to fix its obvious mistakes." Well said.

As Dr. Flier notes, Democrats have no plans to fix this tax bias, though they are likely to "create a new generation of problems." If Mr. Obama is going to slam "the marketplace," he should at least admit the real cause of its ills rather than invent statistics and strawmen.