$750 billion isn’t enough

BARACK OBAMA'S proposed economic stimulus plan isn't nearly enough to counteract a deepening world economic slump, according to a growing number of liberal economists.

Even before the horrendous jobs report that saw the U.S. unemployment rate shoot up to 7.2 percent, many commentators were pointing out that Obama's planned mix of government spending and tax cuts won't be sufficient to replace plummeting consumer demand and a shutdown in business investment.

Obama claims that his program will "save or create" 3-4 million jobs. But that's minimal given that the U.S. economy has lost 1.9 million jobs in just the last four months of 2008--and that nearly 6 million new workers will enter the labor force over the next couple of years.

Economist and New York Times columnist Paul Krugman argued that Obama's plan is too small to counteract what the Congressional Budget Office estimates will be a 6.8 percent difference between what the U.S. economy is capable of producing and what it will produce over the next two years--the equivalent of $2.1 trillion in lost production.

"To close a gap of more than $2 trillion--possibly a lot more, if the budget office projections turn out to be too optimistic--Mr. Obama offers a $775 billion plan," Krugman wrote. "And that's not enough."

Obama's January 8 speech did convey a sense of urgency, as opposed to the head-in-the-sand stance that the Bush administration maintained until the financial system crashed last year.

But by trying to appease Republicans by including about $300 billion in tax cuts in his program, Obama is diverting money from other forms of spending that would have a greater economic impact, as economic advisers Christine Romer and Jared Bernstein acknowledge in their study of the proposal. Romer and Bernstein also point out that even if the spending plan is approved, unemployment will remain 7 percent for years to come.

Obama's program does contain tax breaks for workers--including $150 billion in payroll tax cuts--which will be useful to hard-pressed low-income workers who need it for daily expenses. But everyone earning up to $200,000 per year is eligible, and the upper-income crowd is more likely to bank the money, rather than spend it, which means the stimulus effect will be limited.

Obama also wants to hand $150 billion in tax breaks to businesses to try to induce them to invest. The problem with this approach is that it assumes businesses will hire workers in order to take advantage of a $3,000-per-worker tax cut, even though their markets are collapsing.

"Every dollar spent on a politically expedient tax cut is money that is not spent where it could do more good," a New York Times editorial pointed out. "It also perpetuates the corrosive debate in which taxes are portrayed as basically evil and tax cuts as unmitigated good. That is not a debate that Mr. Obama should engage."

Another flaw in the plan is that huge tax write-offs for business would mean huge payouts from the government.

"The Obama proposals likely would mean that companies with enormous losses from last year and this year could use the losses to help wipe out tax obligations from the previous five years and receive sizable tax-refund checks from the Treasury Department," the Wall Street Journal reported. "For some firms, that would mean cash payments of billions of dollars." And there's little reason to believe that companies would direct this money toward the critical task of encouraging new spending and investment.

According to economist Joseph Stiglitz, such measures would "effectively do little more than another bailout," he said in a January 10 interview on National Public Radio. "Unless great care is taken, that kind of program is likely to have very little stimulus."

BY FOCUSING on giving away money to business via tax cuts, Obama's stimulus plan shares a fundamental flaw of the $700 billion Wall Street bailout known as the Troubled Assets Relief Program (TARP)--the assumption that handing out big money to corporations will in itself spur economic growth.

The central thrust of TARP so far has been to inject tens of billions of taxpayer dollars into the banks in the hope that they'd resume lending to businesses and consumers--and one another. Instead, they've hoarded the cash, both to cover losses in the past and to avoid dealing with shaky counterparts who may not be able to repay loans.

And even though the Federal Reserve Bank has flooded the banks with money by offering loans at interest rates ranging from 0 to 0.25 percent, the banks themselves are highly reluctant to make loans themselves.

Holding on tight to money may make sense from a particular bank management's point of view. But the bankers' unwillingness to lend has choked off growth throughout the economy. The results are painfully clear: record job losses and a collapse in consumer spending, which then leads to further contraction of the economy.

Economists and policymakers are increasingly concerned that this downward spiral will lead to deflation--systematically falling prices. Falling prices may seem to offer immediate relief to cash-strapped consumers, but it will lead to further cuts in investment and jobs. And in relative terms, the vast amounts of business and individual debt would actually increase as prices decline.

TO UNDERSTAND why Obama's plan won't get the U.S. economy out of the ditch, it's useful to review the way the world economic crisis has unfolded so far.

The first phase of the crisis was the collapse of the sub-prime mortgage market that surfaced in the summer of 2007. This involved the collapse of two hedge funds at the investment bank Bear Stearns and the exposure of big losses at Citigroup and other banks that had kept such loans in off-the-books paper companies.

Then, Treasury Secretary Henry Paulson and other government officials assured the world that the problem was "contained" to sub-prime mortgages. But by March 2008, the crisis erupted anew when Bear Stearns collapsed and was forcibly sold off to rival JPMorgan Chase in a deal financed by the U.S. government.

What followed was a run on the so-called shadow banking system--the unregulated $10 trillion in financial markets that equaled the traditional banking system in size. As investors fled arcane financial instruments like collateralized debt obligations--most commonly, giant pools of mortgages packaged into bonds--it set off a chain reaction of forced sales of assets, driving prices downward.

Between August and September, the U.S. effectively nationalized the mortgage giants Fannie Mae and Freddie Mac and the world's biggest insurance company, AIG, to avert an even greater financial collapse--putting the government on the hook for $350 billion.

Then came the collapse of the investment bank Lehman Brothers, which the government allowed to go bankrupt. Lehman's losses led to a second, even more severe phase of the crisis, turning a credit crunch into a credit lockdown that brought the entire financial system to the brink.

Amid this panic, Congress approved the $700 billion TARP program, and European governments responded by semi-nationalizing their banks. (Treasury Secretary Paulson then used the TARP money to directly invest $250 billion into U.S. banks as well, lest the European banks be perceived to have an advantage over their American rivals.)

Propping up the banks isn't the same as reviving economic growth, however. The financial crash has transformed a normal cyclical recession into a prolonged slump and raised fears of a repeat of the Great Depression of the 1930s.

Indeed, the Lehman collapse led to the worst world stock market crash since that era. About $30 trillion was wiped off world financial markets in 2008--a figure equivalent to two years of the U.S. gross domestic product.

The financial crisis, in turn, has brought to a head the contradictions of a world economy in which the U.S. has been the world's importer of last resort. For example, China's dramatic industrialization in recent decades has been driven by U.S. consumer spending that was increasingly fueled by debt as wages stagnated or declined. Now, the collapse in U.S. demand is having a domino effect as factory production plummets in China and worldwide.

Thus, the economic crisis has entered a third, more ominous phase. "Some entertain hopes that we can restore the globally unbalanced economic growth of the middle years of this decade," wrote Financial Times columnist Martin Wolf. "They are wrong. Our choice is only over what will replace it. It is between a better balanced world economy and disintegration."

The financial crisis means that debt-based consumer spending in the U.S. can no longer drive the economy. Moreover, the collapse in business investment means that only government spending can provide the boost necessary to rejuvenate the economy.

But Obama's refusal to spend big right now--and reduce the enormous burden of U.S. military spending--is hampering the government's ability to overcome crisis. According to Stiglitz and co-author Linda Bilmes, the cost of the Iraq war will add up to $3 trillion--and, under the Bush administration alone, the U.S. government has accrued long-term obligations of more than $10 trillion.

Even if Obama's plan does spur economic growth, it won't overcome the longstanding social problems made more acute by the recession--the disappearance of millions of decently paid factory jobs, the lack of affordable housing, limited access to higher education and much more.

That will require not only more government spending, but a revival of working-class organization and struggle to fight for that change.