“An overconfident government throws itself into a dysfunctional culture it doesn’t really understand. The result is quagmire. The costs escalate. There is no exit strategy.” 1 In the rush to solve the current economic problems policymakers base their projections of success on high-level multipliers and big-picture estimates. Often missed, however, are the on-the-ground microeconomic implications of policy proposals, a failure which has led to disappointment in the past.
What can decision-makers expect for policy initiatives and how will these initiatives affect basic hiring and investment decisions? The easy path to analysis is to rely on the broad sophism that government spending and tax cuts, along with a healthy dose of monetary easing, will stimulate sustainable economic growth. However, macro policy experiments in prior administrations, including the most recent Bush administration, were fixed on broad macro initiatives and failed to provide sustained growth due to the disregard for micro foundations. Policy actions based solely on conclusions drawn from large macroeconomic experiments and simplistic multipliers - those that ignore how households and firms will react on the micro level - will not be effective.2 Stated differently, incentives always matter.
In 2008, former President George W. Bush’s fiscal rebate program aimed to stimulate the economy.3 Such stimulus did lead to a brief pick-up in retail spending but did not generate ongoing economic recovery. Certainly, there were other factors involved, but the basic lesson is that such “rebates” were simply handouts that did not alter individual incentives to work, save or invest. Estimates of job creation and sustainable growth owing to these macro policies were wildly optimistic. Policy endeavors that appear effective only when viewed at the 40,000-foot level, without changing individual incentives, generate no permanent stimulus to the economy. This year, President Obama’s stimulus has come in terms of transfer payments, and not sustained job growth. In the latest personal income report we saw that personal income rose primarily due to these transfer payments, and as a result, household saving rates rose, but very little of the additional income was spent. There was little, if any, multiplier for the economy.4
Moreover, unfortunately, the disincentives of specific sector policy proposals may have negative effects on business and consumer market behavior, worsening the recession and damaging expectations for sustainable future growth. If economic policy is to have any sustainable impact on the economy, and generate any follow-on spending in the private sector, there must be a change at the micro level for the individual and the firm. Individuals, not models, generate sustainable economic activity.
