Why Stimulus Today Helps Deficit and Climate Hawks Tomorrow
Federal lawmakers continue to waffle back and forth on the next stimulus package. Negotiations have been characterized as a battle between budget-conscious deficit hawks and big spending progressives looking to advance an agenda—including climate change. The failure to deliver economic relief during this historic crisis suggests neither side has learned the lessons of the 2009 stimulus nor the anemic recovery that followed it.
This is true of both the deficit hawks that opposed further government spending, and the climate hawks who thought such relief did not go far enough. Fiscal spending is most effective economically and politically when it is large and targeted at sectors most affected by the crisis. Failure to pass a big enough stimulus will leave permanent scars on the U.S. economy and psyche. These short- and long-run effects are particularly complicated in discussions around a “green stimulus,” suggesting the need for a sequenced approach that builds momentum toward structural change and deep decarbonization.
Stimulus as Countercyclical Fiscal Policy: Go Big or Go Home
The fiscal response to the economic downturn caused by the Covid-19 pandemic was initially effective but has proven wholly insufficient for the scale of the current crisis. Through over $3 trillion of spending, fiscal policy provided timely support for workers and businesses within weeks of the Covid-19 outbreak. By most accounts, these measures have prevented the crisis from spiraling entirely out of control and are estimated to have kept more than 12 million people out of poverty. However, the crisis is far from over, with more than 40,000 new confirmed cases of Covid-19 per day, over 20 million people either unemployed or working less than they would like (see Figure 1), and more than 160,000 small business closures since March. The most recent jobs data show that the temporary crisis of lockdown-induced unemployment is being supplanted by a full-blown recession. Stimulus is not a singular exercise, but a process of government-induced spending for as long as a crisis lasts, meaning the United States needs more stimulus to dig the economy out of its hole.
We have been here before. Former president Obama’s 2009 stimulus made it clear that countercyclical fiscal policy works but that you need to “go big or go home.” One report estimates that without the American Recovery and Reinvestment Act (ARRA), GDP would have fallen by as much as 14 percent, compared to the 4 percent actual decline; the economy would have contracted for twice as long; twice the number of jobs would have been lost; the budget deficit would have ballooned to 20 percent of GDP; and real GDP would have been about $800 billion lower by 2015. Yet unemployment still hovered around 10 percent two years after the recession began, it was the slowest investment recovery in U.S. history, one-quarter of Americans had lost 75 percent of their wealth by 2011, and many counties across the country never truly recovered.
The administration’s experience also illustrates the political consequences of a weak or delayed stimulus. As one study of the political response to the Great Recession put it, “[Voters] are much more attentive to ends than to means, and they tend to reward or punish incumbent governments based on simple assessments of immediate success or failure.” Despite the financial collapse itself taking place under the Bush administration’s watch, Obama got, in his words, a “shellacking” in the 2010 midterms, due in no small part to the slow economic recovery. While the stimulus may have been an empirical success, the electorate largely saw the ARRA as a failure. As former congressman Barney Frank (D-MA) once quipped, “No one has ever gotten reelected where the bumper sticker said, ‘It would have been worse without me.’” In other words, whomever occupies the White House in 2021 will have to deal with the political fallout of 2020’s failures, with implications for policy agendas of every stripe.
The failure, to be clear, is that any of the offers on the table today would make a huge difference for the economy in 2021, and by extension, the political environment. While current stimulus negotiations have stalled over the total price tag, both the Democrats’ $2.2 trillion plan and the White House’s $1.6 trillion counteroffer include extensions of policies, which, according to the Center for Budget and Policy Priorities, “together form a strong response to the crisis.” Though lacking funding for some key Democratic priorities, the White House plan would still mean a stimulus of around 15 percent of GDP, support for the millions of unemployed, and $400 billion to state and local government to help address budget shortfalls. With the notable exception of much-needed infrastructure funding, both the White House plan and the HEROES Act offer stimulus options consistent with reviews of the 2009-10 experience, a stronger economic recovery, and an improved political outlook for the next administration.
Stimulus Scars: Hysteria and Hysteresis
In addition to its immediate economic and political effects, the second key lesson from the Great Recession is that an economy will not fix itself. Even a short-lived recession leaves long-lasting scars. The Great Recession may have officially lasted only 18 months; however, the U.S. economy did not return to full capacity until 2018, fully a decade after the crisis. Moreover, it never returned to the trajectory of the pre-2007 years. Figure 2 shows how growth since 2007 declined during the recession itself and has remained at a permanently slower rate ever since. Other indicators, such as negligible inflation and sluggish wage growth, further suggest the economy remained below its potential by the time Covid-19 struck. As such, many now argue the Obama administration should have implemented a much larger, longer, and more equitable rescue package at the time and maintained a more active fiscal policy stance throughout the recovery period.
What the Great Recession helped reveal is that spending (or stimulus) today affects potential tomorrow through what economists call a “hysteresis” effect. A worker unemployed today may drop out of the workforce entirely tomorrow or not have the skills to compete by the time the economy is able to rehire them. Businesses are less likely to invest in future plants and equipment for tomorrow if they do not see demand for their product today. Difficulty finding a new job makes it less likely someone takes the risk of becoming an entrepreneur or changing careers through education or by moving across the country. In other words, it is not just a matter of returning the economy to full capacity, but how long it takes to do so, with every moment of delay increasing the effects of the downturn on the economy’s long-run potential to deliver jobs, growth, and innovation.
Importantly, these effects undercut the arguments of deficit hawks, who worry that government debt will have catastrophic consequences for the U.S. economy, despite growing evidence to the contrary. Even a small spillover from current spending into future output—and there’s reason to believe these “hysteresis” effects are much greater than formerly appreciated—means government stimulus would effectively “pay for itself” as growth prospects improve for longer than the spending lasts. Further, with interest rates at historic lows, so long as the stimulus contributes to nominal income growth above near-zero, the debt-to-GDP ratio will fall by construction. With the U.S. government a long way from being a credit risk in international markets, and debt servicing costs continuing to fall with nominal interest rates, further government debt is all but guaranteed to improve the United States’ fiscal situation in the future so long as it is used to improve both short- and long-run growth prospects. Which, as discussed above, is exactly what another round of stimulus would achieve.
So far, Congress has heeded few of these lessons, mistaking the “k-shaped” recovery for economic boomtimes, all but guaranteeing years of stagnant growth, wages, and investment—not to mention a deteriorating budget balance as tax revenues decline. According to the Congressional Budget Office, the economy is now 6.5 percent below its potential thanks to Covid-19, already the largest such output gap since estimates began in 1949, and likely an underestimate at that—and it does not expect this gap to close for more than a decade (see Figure 3 above). In other words, every day Congress waits to restart the economy is a day its future potential to employ workers, stimulate investment, and generate new innovations erodes even further, even as the difficult budget decisions are kicked down the road.
Green Stimulus: Playing the Long Game
These “hysteresis” effects are only one way in which stimulus spending (or lack thereof) may be more important for its long-run effects than immediate impacts. Climate advocates point to the ARRA’s investments in clean energy as proof of the potential for a massive “green stimulus” to decarbonize the U.S. economy while lamenting the lack of such provisions in current proposals. Of the $787 billion in spending in the ARRA, $90 billion went to clean energy investments, the largest clean energy investment in history at the time. By March 2013, over 70,000 projects had received cash grants, creating an additional 27 gigawatts of installed renewable capacity, nearly doubling the total amount of renewable electricity generation and capacity in the country. The ARRA also created more than 26,000 jobs in renewable energy, a further 5,000 in green innovation, and as many as an additional 40,000 induced jobs thanks to this spending.
While these are impressive numbers, they say nothing to the immediate imperative of stimulus: return spending to normal levels as soon as possible. Though helpful, it is not clear that green stimulus can operate at the speed and scale required for rapidly addressing a massive decline in aggregate demand, such as the current crisis. For example, according to one recent study, each $1 million of green spending under the ARRA created 15 new jobs, which is about in the middle of the range of programs implemented at the time, suggesting that creating green jobs is not an especially effective policy lever. The authors also find that few of these were created over the short term, when the need was greatest, and that spending was most effective in communities that already had many of the green skills required for these positions, in much the same way as a 2012 World Bank review of the literature.
On the other hand, short-term stimulus spending can multiply its long-term impact if it helps drive down the costs of critical, especially green, technologies by either investing in the emergence of new technologies or deploying existing ones at scale. For example, the Section 1705 Loan Guarantee program in the ARRA helped finance the first five utility-scale solar photovoltaic projects in the country, which reduced costs and “opened the floodgates for private investors.” The program also gave $465 million to Tesla, now the most valuable car company on the planet, dramatically accelerating the adoption of electric vehicles in this country. The package also accelerated innovation in clean energy by providing funding for basic research, establishing the Advanced Research Projects Agency-Energy (ARPA-E), and facilitating faster green patent processing. The number of renewable energy patents in the United States increased by a factor of five (see Figure 4) over the course of the stimulus package and reached a high of 10 percent of all U.S. patents in 2010, a share that has been falling ever since.
This tradeoff between short-term stimulus and longer-term benefits furthers the notion that green stimulus is best thought of as the first step in a “sequencing” approach that ratchets up over time as the positive co-benefits of climate policy manifest in the community. Similarly, Obama’s green stimulus was only ever meant to be one “blade of the scissors,” the other being comprehensive cap-and-trade legislation that would cut pollution in carbon-intensive sectors. However, this sequencing clearly failed to materialize with the bill failing to pass Congress in 2010. While this has been blamed on the unique political problems of carbon pricing, or Obama’s inability to mobilize grassroots support in the face of well-funded political opposition, it is clear that stimulus needs to play a role in either making the case for further climate action, or at least creating the stable political and economic environment for large-scale reforms.
The Magnetism of Stimulus
Economists borrowed the term “hysteresis” from science, particularly the study of magnets, where the word is used to describe how materials can remain magnetized even after the magnet is removed. A fiscal stimulus operates in much the same way. It is just as important that we understand the long-term implications of fiscal spending as its immediate effects on the Covid-19 recession. We know from Obama’s stimulus that further fiscal spending can address the current downturn. The decade-long recovery, however, supports the notion that close enough just is not good enough in a crisis. An ambitious climate agenda needs to balance these forces—on the one hand, backing those programs that can most immediately deliver economic growth while supporting the political and technological context for future reform on the other.
So, like two opposing poles of a magnet, let us hope the two sides of U.S. politics can come together, just for a moment, to do what needs to be done.
Lachlan Carey is an associate fellow with the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.
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