What should Obama or Romney do about the economy next year?

Political strategists, who don’t know any more about economics than the rest of us, do know this: when the economy is bad, blaming it on the imcumbent can put the challenger into office. Barack Obama campaigned successfully against White House economic policies. Now Mitt Romney is mounting a similar campaign against him.

That’s politics, and not really my thing, but what about the economy? I mean, setting politics aside, what should President Obama do if he’s re-elected? What should Mitt Romney do if he’s elected instead? What should Congress, whatever parties or factions of parties control it, do next year? Which ideas are worth pursuing by those in office when the political dust has settled?

After spending a great deal of time reading studies about recent efforts at economic stimulus, and political debate over whether stimulus works, I’ve come to some conclusions.

The first conclusion is, we need to stop asking the question, “Does stimulus work?” as if the answer is either “yes” or “no”. The true answer is, it depends on the stimulus. The Romney campaign’s claim that the answer is “no” is wrong – and there are more independent studies to support “yes” than otherwise – but the Democratic claim that it’s “yes” is at least partly wrong. Next year’s president should know the difference regardless of which guy it is.

Let’s start with the area where Romney is right. Anything designed to provide short-term stimulus for one particular part of the economy, with no other intended effect other than short-term stimulus for one particular part of the economy, is a waste of time.

“Cash for Clunkers” was an epic fail. It worked for a little while, and then when it was done, auto sales slumped again. It may even have delayed a broader rebound of auto sales (which seems finally to be under way this year) by releasing some pressure to replace older cars. Next year’s president should not support anything that “moves up” later spending unless there is some other benefit.

Next, how much can we reasonably infer from economic studies of past attempts at stimulus? The answer is, not as much as you would hope. For example, the President’s Council of Economic Advisors thinks the American Recovery and Reinvestment Act three years ago created or saved millions of jobs. Maybe it did, but the study used to support this conclusion fails to dial out the effects of the other stimulus programs that went into force over the same period.

What about tax breaks? Congress, indirectly controlled in the past two years by the unified front of the Tea Party freshmen, has protected and prolonged tax cuts for the wealthy, and from time to time both this administration and the previous one has done small tax cuts for other people. There are divergent schools of thought on this, but you can ignore all of them, because we know what happened after these actual tax breaks were enacted. The answer is: if people are worried about the economy and about their own personal financial situation, and you give them money through a tax break, they’ll bank it, not spend it. Footnote: poor people may spend it but they will spend it all at Wal-Mart and the rest of the economy won’t be helped. This, too, is not speculation but based on what economists believe actually happened during a recent tax rebate program.

The more I view this as a politically independent civilian, the more I conclude that the federal government can do only two things to promote economic recovery in the short-term:

  1. Repair aging infrastructure. Highways and bridges and other national infrastructure need to be renewed periodically and much of it is overdue for this. Whatever it costs today, it costs more tomorrow. Cutting back on this – what the private sector calls deferred maintenance – doesn’t help the current situation and makes the future worse. This form of stimulus for the lagging construction sector is good in the short-term but also helps in the long-run, because it is not make-work.
  2. Be careful about cutting government spending that supports contractor jobs. The U.S. economy dwarfs even “big government,” which is why some stimulus programs enacted by Congress have turned out to be too small to help, even if they seem enormous. But the amount of U.S. employment tied to government contracts is big enough to have a big effect on overall employment and prosperity. This is especially true of defense contractors.

Deficit reduction is, in the long run, every bit as important as you’ve heard, but in a fragile economy a major cut in government spending becomes an anti-stimulus program that would produce a new recession, as has happened in Britain after dramatic cuts to government spending. And when the economy shrinks, tax revenue declines, which makes the deficit worse. Everyone wants Washington to do something, but Washington needs to think very hard about what it should not do.

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