There's an old maxim in business: you've got to spend money to make money. That's where we are now as a country. We've exhausted the possibilities of the buy-everything-you-can-on-the-planet school of economic thought.
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One point becomes clear when looking at the current state of the US economy: without a stimulus we are in deep trouble. Consider the following points from the latest FOMC statement from the Federal Reserve:

Information received since the Committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly. Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight. The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

Let's take a look at some charts to get more detail on the Federal Reserve's statements:

The year over year change in industrial production is approaching the rate of change of the mid 1970s recession.

Housing starts are at their lowest level in over 40 years

The year over year rate of change in employment is approaching the level of the 1980s double dip recession.

And this chart from a recent IMF report indicates that global industrial output and manufacturing shipments are falling off a cliff.

Let me add a few other data points:

The year over year rate of change in personal consumption expenditures are falling off a cliff. For an economy that depends on consumer spending for 70% of its growth, this is devastating.

The Bureau emphasized that the fourth-quarter "advance" estimates are based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4). The fourth-quarter "preliminary" estimates, based on more comprehensive data, will be released on February 27, 2009.

The decrease in real GDP in the fourth quarter primarily reflected negative contributions from exports, personal consumption expenditures, equipment and software, and residential fixed investment that were partly offset by positive contributions from private inventory investment and federal government spending. Imports, which are a subtraction in the calculation of GDP, decreased.

Let's look at this from another angle. The equation for GDP (Gross Domestic Product) is Consumer spending (C) + Investment (I) + Net Exports (E) + Government Spending (G) = GDP.

We've already covered personal consumption. It's dropping hard and fast (see the chart above). As for total private domestic investment, consider the following percentage changes from the preceding quarter starting in the 4th quarter of 2007: (-)11.9%, (-)5.8%, (-)11.5%, 0.4%, (-)12.3%. Because the US is a net importer the exports part of the equation is moot. That means the only thing holding up the US economy is government spending. And considering the mammoth drops in investment and consumer spending in the latest report (-12.3% and -3.5%, respectively) neither of these numbers appears ready to turnaround anytime soon.

Now -- let's look at several possibilities for action. First, let's do nothing. While no path is guaranteed, the following points illustrate the inherent problems of that course of action:

What would the economy look like without fiscal stimulus? ... The lack of stimulus means that the collapse in private spending drives the economy down much further. Without the stimulus, GDP growth stays negative for all four quarters of 2008 , and the year averages minus 3.6% growth, instead of minus 2.5%. And the recovery in 2010 is far more anemic, with growth of just 0.7%, instead of 2.2% in [IHS Global Insight's] baseline [forecast]. Without the stimulus, the unemployment rate rises to 10.2% in mid-2010, a full percentage point above the baseline. The loss of jobs is both deeper and more prolonged. Without stimulus, the cumulative loss in jobs peaks at 6.9 million in the second quarter of 2010, rather than at 5.0 million in the fourth quarter of 2009. -Nigel Gault, IHS Global Insight

There are some Republicans who are arguing that tax cuts are the answer. But there are several problems with that. The first is tax cuts were advertised as an engine of job creation in 2003 and we got one of the lowest rates of job creation on record:

President George W. Bush entered office in 2001 just as a recession was starting, and is preparing to leave in the middle of a long one. That's almost 22 months of recession during his 96 months in office.

His job-creation record won't look much better. The Bush administration created about three million jobs (net) over its eight years, a fraction of the 23 million jobs created under President Bill Clinton's administration and only slightly better than President George H.W. Bush did in his four years in office.

Here's a picture of the data:

In addition, recent history demonstrates that tax cuts will go to savings and paying down debt rather than consumption. In addition, there is little reason for business to invest in production right now:

Start with the tax side. The plan is to give a tax cut of $500 a year for two years to each employed person. That's not a good way to increase consumer spending. Experience shows that the money from such temporary, lump-sum tax cuts is largely saved or used to pay down debt. Only about 15 percent of last year's tax rebates led to additional spending.

The proposed business tax cuts are also likely to do little to increase business investment and employment. The extended loss "carrybacks" are primarily lump-sum payments to selected companies. The bonus depreciation plan would do little to raise capital spending in the current environment of weak demand because the tax benefits in the early years would be recaptured later.

That leaves pure spending. Professor Mark Thoma had a great excerpt on this topic recently. Consider the following:

Is Public Expenditure Productive?: From the 1930s to the late 1980s, macroeconomists viewed government spending as rather homogeneous. They asked whether government spending crowded out private investment, drove up interest rates, or spurred consumer spending. They argued whether funding government expenditures by taxation had different effects than funding by issuing new government debt. They gave relatively little attention, however, to the different ways the government spends its money-on defense, on roads, on food stamps, and so on. Economist David Aschauer of Bates College dramatically altered macroeconomists' view of government spending with a paper he wrote in 1989, however. Aschauer's analysis places a particular kind of government spending - nonmilitary public investments, such as roads - at center stage. Aschauer finds government investment is so important for private sector productivity that a decline in public sector investment might account for much of the productivity slowdown observed in the 1970s and 1980s.

Aschauer asks whether private sector productivity is improved by public sector investments, and whether public sector investments have a different effect on private sector productivity than does other government spending. He assumes a Cobb-Douglas style of production function and uses two dependent variables - output and a measure of productivity called "total factor productivity - to study the effects of government spending on productivity. Aschauer assumes that both output and productivity depend on labor, the private capital stock, the public nonmilitary capital stock (for example, roads), and, perhaps, on other government spending. He also allows output to depend on the intensity with which the capital stock is being used, as measured by the capacity utilization rate of the private sector.

When Aschauer estimates an output equation that accounts for labor, capacity utilization, and a time trend, his Durbin-Watson statistic is 0.63. Either there is serial correlation in the model's underlying disturbances, or an important variable has been omitted. When Aschauer adds the public stock of nonmilitary capital to the output equation, the Durbin-Watson statistic no longer evidences serial correlation, and public capital becomes statistically significant. The public, nnonmilitary capital stock is also significant in Aschauer's productivity equation. Public investment expenditures translate into higher private sector productivity and higher private sector output.

Aschauer finds no evidence of public military capital raising output or productivity, nor does he find the flow of spending on on capital goods to have any effect on output or productivity. Public spending raises private sector productivity to the extent that public sector spending is on nonmilitary capital goods. How government spends its money matters! It is not government spending, as such, that spurs private productivity, but rather specific government investments in capital goods that makes the private sector more productive.

We could reasonably worry that that the direction of causation runs not from government spending to output, but the other way around, from output (which translates into income) to government spending. But if this were the reason for Aschauer's findings, we would expect both military and nonmilitary capital to reflect such an effect of output on expenditure. The fact that only public-sector spending on nonmilitary capital goods shows a link with output suggests that the effect we see reflects a causal effect running from nonmilitary capital to output, and not the other way around.

Let me add some real world examples. From my blog:

Ever wonder how China gets 10% growth? It's called infrastructure spending; in some ways they are essentially building new cities over there. Done properly it provides an incredible competitive advantage to a country. Also consider this: Asia has invested heavily in elementary education -- education through high school. Their education is stringent at those levels. Guess what? It made the work force incredibly productive and helped the economy as a whole.

There's an old maxim in business: you've got to spend money to make money. That's where we are now as a country. We've exhausted the possibilities of the buy-everything-you-can-on-the-planet school of economic thought. We're in debt up to out eyeballs -- we are in fact choking on all of the debt we have wrapped up in consumption. We need to change models. That means we need to invest in new technologies and improve our basic infrastructure to attract and support this new business. It's really that simple.

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