WHAT DR. AMAR

BRINGS TO THE

US CONGRESS

WHAT TO DO

WITH DETROIT IS

MORE A NATIONAL STRATEGIC DECISION

Paid for by Amar for Congress

A. D. Amar, Ph.D.

Professor, School of Business

■ 973 761 9684 ■ amaramar@shu.edu ■ http://pirate.shu.edu/~amaramar

How to Inject Stimulus into a Leaky Economy

             Following the House of Representatives' approval of the proposed $819 billion stimulus package, the Senate now finds itself grappling with a fundamental but difficult question: to what extent will spending all this borrowed money revive the US economy and get our nation out of our economic woes? The presumption that massive public spending will get us out of recession has to be questioned, given that in recent decades America has been transformed into a consumer nation.  In fact, despite the enormous sum of money being proposed, this package may only offer a temporary effect on the economy—much like former President Bush's $50 billion stimulus rebates last year.  

             To successfully determine the cost-effectiveness of the proposal, it is important for the Senate to understand that the American economy currently suffers from a double-ended leakage problem that reduces the effectiveness of any stimulus package. This double-ended leakage—both in terms of spending on imports as well as the loss of corporate profits to foreigners—will ultimately have the effect of blunting the intended boost to the U.S. economy by curtailing the circular flow of this capital within the United States. Under these circumstances, monotonically stimulating consumption will not help as much as the $819 billion price tag implies. Whereas stimulating demand for goods and services will surely generate some jobs, much of the money will leak out of the country. Therefore effect of all consumption stimuli, such as rebate checks and earned income tax cuts, will be about the same. They will cause short-lived prosperity.  

             Although expenditures in infrastructure, education and healthcare are much less leaky and strategically good for America, they will do very little to quickly revive a sluggish economy. Money will not flow evenly to all sectors. Increasing employment in these sectors will not work for too long due to the lack of the circular flow. Such allocations will be an inefficient use of the borrowed stimulus dollars towards achieving job growth. We should invest in these sectors for the sake of improving the long-term outlook of the economic environment, not for quick stimulation of the economy. Secondly, because the demand in these sectors is steady, the stimulus will increase wage pressure. Whereas some funds should be allocated to these sectors to keep America competitive, they should not be the primary focus of the stimulus.

             Investing in alternative energy will fix some leakage in our economy if the alternative energy replaces imported energy, such as the proportion of U.S. crude oil consumption not produced in places like Alaska or the Gulf of Mexico. If we invest in alternative energy that replaces domestically produced energy, the net effect may be marginal. It will not be effective in stimulating the economy. There will be less circular flow and high leakage because the domestic industrial infrastructure of this industry is not fully developed. Again, although we should make some investment in alternative energy, it cannot be the main source of the stimulus. The employment demand in this sector is also relatively healthy and thus likely to cause wage pressure, resulting in reduced productivity of the stimulus dollars.

             The primary focus of the stimulus for getting the full effect through high circular flow and low leakage should target stimulating the production side of the economy. This stimulation will increase meaningful employment, increase supply (domestic supply), increase demand and further increase in employment. The result will be a vibrant, healthy economy in a rather short span of time.

             To achieve the above, we need to allocate stimulus dollars in the following areas:

 Make federal cash subsidy payments to all employers for hiring qualified employees. An employee who is eligible to pay payroll tax and federal income tax should be qualified for employment rebate under this part of the stimulus package.

 Pay cash subsidy to businesses for domestic value-added by them based on the cost of materials as compared to the cost of sales. The subsidy should increase at an exponential rate as the firm increases its domestic value added. This recognizes that the initial increases in domestic value-added are easier to attain than the later increases in value-added.

 Allow itemization of capital losses to individual tax payers to the limit of their taxable income. This tax money saved by the individual investors will very quickly find its way back to capital markets, lifting up values of equities and fixed income securities.

 Give financial incentives to businesses for labor productivity enhancement and investments in innovation and technology. This will make America more productive, competitive and plug the leakage for a long time.

 Make investment in industrial infrastructure, such as technology clusters, incubators, and broadband technology.

             Doing the above will quickly and firmly bring back economic growth in America.  However, in case of confusion, the litmus test for deciding how to allocate the stimulus should be guided by an answer to the following question: how many of the almost 72,000 jobs lost on January 26, 2009 in America could come back by an allocation of the stimulus dollars—and how does that number compare with the costs of borrowing an additional $819 billion on top of the record fiscal deficits the federal government has been running in recent years?