Sunday, February 27, 2011

Why Government Stimulus Packages Cannot Work

I have been thinking more recently on why Keynesian stimulus policies do not and can not work. Specifically, for some reason, I have returned to my thinking here on how startups are the source of job creation.

The idea behind stimulus is that government spending in the economy will put people back to work in the companies that already exist. The government money is necessarily going to those companies which already exist. Those companies are supposed to increase production and, thus, find a need to hire more employees. This seems logical on the surface. However, if we understand the typical history of production in a firm or industrial sector, we will see how and why this is mistaken.

When a company first starts up, based on a new product idea or a new way of doing things, such production is necessarily labor-intensive. There is a period during which one has to discover the best way of doing things. Rarely is it the first way you find. Over time, new ways of doing things are discovered, ways of cutting costs without harming quality are discovered, etc., and fewer and fewer people are needed to produce more and more. More automation is introduced, etc. Thus, as an industry grows, the growth rate of employment is not going to go up at the same rate as it did in the early years of production. In fully mature industries, we in fact see a gradual decrease in the number of workers necessary to do produce those goods. An industry, like agriculture, may even go from almost everyone working in the industry to almost no one working in them as mechanization comes to dominate.

Thus, it is when companies are in their infancy that they need large numbers of workers. Start-ups hire the most people. But stimulus package money does not go to startups. It goes to well-established industries. Those industries can increase production without increasing employment because so much of what they do is automated. Run the machines faster, or buy new ones, and you are making more. Thus, the money does not in fact stimulate the economy. If anything, it results in an increase in production in already-established industries, creating a new bubble in those industries -- and/or driving up prices in them. Whatever it is that government is spending the money on will begin to have higher prices. Thus will we see inflation, but not improved employment. That's the only result of stimulus packages -- as we have seen with the unchanging unemployment rate and the increase in food prices.
Post a Comment