by Daniel Lacalle via Mises
The United States retail sales and jobless claims weakness, significantly below estimates, coincides with the largest fiscal and monetary stimulus in history. Something is not right when these figures come significantly below estimates in an environment of massive upgrades to gross domestic product (GDP). Why?
The diminishing returns of stimulus plans are very evident. Artificially boosting GDP with large government spending and monetized debt generates a short-term sugar high that is rapidly followed by a sugar low. The alleged positive effects of a $1 trillion stimulus plan fade shortly after three months. I recently had a conversation with Judy Shelton where she mentioned that the recovery would be stronger without this latest massive stimulus package. The economic debacle happened due to lockdowns and the recovery comes from the reopening. We need to let the economy breathe and strengthen, not bloat it.
The diminishing returns of stimulus plans are evident. A $20 trillion fiscal and monetary boost is expected to deliver just a $4 trillion real GDP recovery followed by a rapid return to the historical trend of GDP growth this will likely lead to new record levels of debt, weaker productivity growth and slower job recovery. The pace of global recoveries since 1975, according to the OECD shows a weaker trend.
Deficit spending is mostly devoted to current spending, which leads to an almost negligible potential growth improvement. If any, evidence suggests fiscal multipliers are poor, even negative, in highly indebted and open economies.
We must be cautious of the excess of euphoria that emerges from many statements about the so-called European “Next Generation” funds. Many of the optimistic estimates seem to forget the negligible effect of previous similar plans.
The sharp increase in contributions to the European Union Budget and the tax increases announced by some countries like Spain will likely diminish the net effect of these funds.
All the success or failure of the European Recovery Plan rests on the estimates of the multiplier effect of the investments made. And the prospects are not good if we look at history.
The average impact of the last programs such as the 2009 Employment and Growth Plan, the Juncker Plan or the Green Directives to support investment in renewables has been extremely low. The empirical evidence from the last fifteen years shows a range that, when positive, moves between 0.5 and 1 at most … And in most of the peripheral countries, they have been negative.
According to the European Union’s own estimates, the Juncker Plan generated between 2014 and 2019 a total impact pf +0.9 percent in GDP and added 1.1 million jobs from €439 billion invested. The return on invested capital of this massive plan was beyond poor. And let us remember that the Juncker Plan was used entirely for investment projects with expected real economic return and without the amount of current spending and political intervention of the 2021 Recovery Plan.
Can we really believe in an impact of 4 percent on GDP in three years from these European funds as the average consensus estimates when the Juncker Plan generated—if we believe it—0.9 percent in five years?
The government of Spain, in its Recovery, Transformation and Resilience Plan, states that “in aggregate terms, the employment generated by the Plan will represent twelve jobs for every million euros invested.” Twelve jobs per million spent!
The multiplier effect and its structural impact depend on execution and efficiency factors that are more than questionable. The likelihood that these funds will be malinvested or squandered is enormous.
The idea that hundreds of magnificent and profitable projects will suddenly appear is also questionable. It is very difficult to believe that, suddenly, thousands of profitable and job-creating projects will appear when they were not carried out in recent years with interest rates at historic lows, unlimited liquidity and growing investment appetite.
These so-called stimulus plans have a huge risk: that they involve a huge transfer of wealth from the middle classes and taxpayers destined for political spending without real economic return and investments of doubtful profitability.
There has never been capital available for technology, digitization, and sustainability investment. These investments do not need political direction or funding.
Cheap money, increased public intervention, and massive stimulus plans have not worked as drivers of productivity and potential growth. The path to stagnation and zombification was already a problem in 2018. We need private investment and free trade to boost productivity. We need open economies with a thriving entrepreneurial spirit, not an economy based on spending and debt. The problems created by the chain of the stimulus of the past years are clear: elevated debt and weak growth. More spending and debt will not solve them.
Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Freedom or Equality (2020),Escape from the Central Bank Trap (2017), The Energy World Is Flat (2015), and Life in the Financial Markets (2014).
He is a professor of global economy at IE Business School in Madrid.