Inappropriate stimulation

Mario Rizzo writes at the ThinkMarkets on Inappropriate Stimulation. He writes

As we now know, job losses have been far greater than average in construction. But financial services, American automobiles, retailing (based on consumer credit), computer services, technical consulting, research and development and other areas dependent directly or indirectly on cheap credit have also lost jobs.

“This rapid deterioration [in employment] has prompted talk that some industries are being partly dismantled.”

What is happening is a massive re-allocation of resources mainly due to the excessively low interest rate policy of the past few years – but also partly due to certain sectoral shifts. The American car manufacturers, for example, are suffering both from the contraction in credit and from their own long-term inefficiencies.

The fiscal stimulus program is designed to stimulate where economic activity has deteriorated and there are job losses. Many of these areas are those that had over-expanded. As we have been saying for some time on the blog, the effect of this kind of stimulation is to slow down the re-allocation of resources. It will not succeed, however, in preventing it. What it will do is prolong the recession.

There is no denying that some areas of economic activity are depressed simply because of overall pessimism and fear, including among lenders. This is reflected in the widespread diffusion of job losses.

These areas do not need to contract in the long run. Yet planners do not have the knowledge to know exactly which ones are in this category. The way to dissipate the general pessimism, for example, is to prevent outright deflation (which is not in sight) and to allow individual markets to equilibrate quickly. Delay causes uncertainty.

The necessary re-allocation of resources that must be a part of any recovery should not be hampered in the name of aggregate stimulus. The neglect of issues such as this is why the crass “Keynesianism” that is being peddled in the media and by those who should know better is grossly inadequate to the solution of our economic problems.

As I have argued before the whole point about falls in profits is that it signals that companies should change what they are doing and how they are doing it, or cut back on production or exit the industry or some combination of these things. That is, some areas of the economy need to contract and government handouts and stimulus measures just delay this necessary adjustment. Resources need to be reallocated and market pressures and discipline are the quickest way of achieving the necessary changes. Removing market discipline via government interference gives businesses a reprieve that the market wouldn't give them and prevents adjustment, to our long-run cost.