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Congress Should Not Have Passed Another Stimulus

Why the second COVID-19 stimulus package will likely be harmful in the long run

December 24, 2020

Members of Congress feverishly negotiated a second COVID-19 stimulus bill in order to pass it before the end of the year. While Democrats and Republicans disagreed over the size of the package, a majority of members from both sides supported some form of it as a means to stem the economic fallout from COVID-19.

Instead of picking winners and losers or stimulating demand, Congress should focus on unemployment insurance to ensure people without work are able to withstand this difficult time. 

Like Congress, a number of economists believe we needed a stimulus package of nearly a trillion dollars. Some others argued Congress should focus on a more targeted stimulus package. But all forms of fiscal stimulus have shortcomings, which are made even worse by our current situation.

Governments typically engage in fiscal stimulus during a recession to stimulate aggregate demand. In theory, putting more money in people’s pockets allows them to spend more on goods and services from businesses. These businesses in turn are able to hire more workers, who then increase their spending, causing a virtuous cycle.

But stimulating aggregate demand is difficult now. The decrease in spending we have been experiencing is not due to a recession; it is due to fears about COVID-19 and government restrictions. In fact, the decrease in spending is concentrated in specific industries which consumers widely view as risky.

A more targeted assistance to specific firms and industries is a better idea than the typical stimulus program. However, it still relies on politicians to make the correct choices, or the spending will be ineffective. With a national debt above $27 trillion and a budget deficit of $4 trillion this year, we don’t exactly have the money to keep this up. 

Economics teaches us that people act in ways that meet their wants and needs. Most people understand this easily in the market setting. Yet, once people enter government service, they tend to forget this and assume that they act with pure benevolence. But politicians are still self-interested in office just like they are when they purchase goods and services. 

Economics also teaches us that people suffer from a lack of knowledge. Through interactions and exchanges in the market, we generate knowledge. But over time, people do not gain perfect knowledge—that would be too expensive and time-consuming, even if it were possible. People are forced to act with incomplete knowledge all the time. This holds true for politicians as well.

Without reading all 5,000+ pages of it, we should expect that any stimulus is imperfectly designed, based on the incentives and lack of knowledge facing members of Congress. Directly helping those harmed by COVID-19 and our response is popular among constituents, hence the bipartisan support for some form of stimulus. In the previous stimulus package, large portions were spent on projects that were unrelated to COVID, but were popular. It also suffered from a poor design, with large firms getting targeted assistance intended for small businesses.

The most difficult problem facing policymakers trying to design an effective fiscal stimulus program is which firms or industries should be supported. Policymakers have no special foresight of what will survive the pandemic and what industries will meet changes in consumer needs after the pandemic is brought under control.

The market is the process by which that knowledge is generated. As my students tire of hearing me say, entrepreneurs take risks trying to find ways to meet previously unmet consumer needs. These are not known ex-ante, rather they are discovered through sales in a process of trial and error. Profit encourages entrepreneurs to continue offering that product, while simultaneously encouraging others to follow their lead. Likewise, loss forces firms to adapt to consumer needs, so that those resources can be used to provide something consumers actually want. There is no reason to assume that policymakers are privy to some secret knowledge, and absent the profit-and-loss mechanism there is little to help encourage them correct past errors.

Now this theory may sound great copied straight from Frederick Hayek’s chalkboard, but what about the real world? Isn’t the real world trickier? Here are a few examples. 

In the recovery from Hurricane Katrina, there were substantial problems with federal aid being late or not useful. It was local groups, churches, and individuals who quickly helped others in need and spurred the recovery process. FEMA struggled to find the best uses for resources, while community members and private companies were quicker to respond, and did so more effectively. 

Rapid changes make imagining solutions to new problems difficult, but bureaucracies are particularly ill-suited for rapid response to changing circumstances. The government should uphold the rules of the game, allowing entrepreneurs to experiment and lead the recovery. Instead of propping up businesses they think are important or are popular with their constituents, policymakers should allow people to determine which meet their changing needs by buying their products.

In the aftermath of World War II, economists worried that the sudden return of troops to the private sector would cause unimaginable turmoil. Without ongoing government management to guide the transition from a wartime to peacetime economy, we would experience “the greatest period of unemployment and industrial dislocation,” and an “epidemic of violence.”

Despite these dire warnings, the government powered down the war machine and returned to normalcy. Real consumption increased, durable goods orders doubled, and the unemployment rate only rose from 1.9 to 3.9 percent. The removal of central planning allowed firms to shift from military to consumer goods, each experimenting with different goods that met consumer needs. Several years of interruption by the war did not destroy human capital or the entrepreneurial spirit.

Similarly, we should not expect the human and physical capital of businesses to vanish due to the economic calamity caused by COVID-19. Measures we already have in place, like unemployment insurance, can provide a basic safety net and help struggling families until the fear of COVID-19 and economic restrictions end. Extending unemployment insurance or increasing the benefits above the normal level will both help those out of work without requiring the government to select industries and firms to support. 

Stimulus checks will not be effective in an environment where people do not want to and are legally prohibited from using certain businesses. Any support for struggling industries will likely go to ones with political connections or that are popular with constituents. Propping up old industries will just slow down our recovery this coming spring. Instead of propping them up, policymakers could choose to loosen restrictions to allow the firms to find ways to operate safely, given the risks and the evidence of transmission occurring in these businesses. 

Any fiscal stimulus inevitably contains a large amount of wasteful spending. Considering the incentives facing members of Congress and the knowledge problem, no amount of good intentions will save it. Rather than picking winners among firms and industries, policymakers should leave it to the people and let entrepreneurs shape the recovery.

Conor Norris is a research analyst at the Knee Center for the Study of Occupational Regulation at Saint Francis University. He graduated from George Mason University with an MA in economics. 

Conor Norris is a Catalyst Policy Fellow and a Research Analyst with the Knee Center for the Study of Occupational Regulation (CSOR) at Saint Francis University. His areas of interest include occupational licensing and health care scope of practice laws, monetary policy, and long-run growth. Conor is an alumnus of the Mercatus Center MA Fellowship at George Mason University, where he received his MA in economics in 2018. He interned at the Cato Institute in 2017 in the Center for Monetary and Financial Alternatives. He loves reading good history books and bad puns and is still bitter that the Star Wars expanded universe is no longer cannon. Conor grew up in Williamsport, Pennsylvania and after spending two years in Arlington, Virginia, he now lives in Altoona, PA.
Catalyst articles by Conor Norris