Fifty Reasons for Economic Stimulus Failure

by Inya Ivkovic, MA

Economists have a long list of things threatening economic recovery in the U.S. The list of usual suspects typically contains the still weak banking system, even weaker housing market, consumers neck-deep in debt, and businesses reluctant to make leaps of faith towards new investment. But there are also exactly 50 more culprits operating in stealth mode, thus they’re even more dangerous and at least equally devastating — the U.S. states. You probably wouldn’t think that federalism, often described as one of America’s greatest advantages, could have actually become a serious hurdle to the U.S. recovery. But that just might be the case.

Granted, state governments nowadays are often ridiculed, albeit most as a result of their own, purely self-inflicted policies, such as California issuing IOUs to pay its bills, or New York’s statehouse becoming the unlikely subject of coups and senatorial sit-ins, just like in the ’60s. Yet, state politicians and their reckless ways do not actually have the power to kill the recovery. What may kill it for real is simply the way state governments conduct their day-to-day business.

Now, let’s go back to the $787 billion dumped into the latest federal stimulus package. The idea behind it was that, as the economic cycle turns for the worse, the federal government should increase spending and introduce tax cuts to counteract its adverse effects. In other words, federal fiscal policy is countercyclical.

However, on the state level, things couldn’t be more different. Each of the 50 U.S. states is required to balance its budgets. This means that, during economic downturn, states often cannot afford to increase spending and cut taxes. Quite the contrary, most of them resort to contractive fiscal measures, which, in turn, result in job losses, plummeting consumer confidence, investment declines, and, by extension, shrinking tax revenues. So, in order to counteract the downturn, states need to increase taxes, which is precisely what most of them are doing. In other words, states’ fiscal policies are pro- cyclical, as they are only amplifying the effects of a downturn, instead of counteracting them. So, even as the federal government is pouring billions of dollars into the economy, all that states are doing are diminishing each bailout dollar’s effects.

True, states’ cutbacks haven’t been nearly as dramatic as they could have been, had the federal government not allotted roughly $140 billion in economic stimulus money for state governments. According to the Center on Budget and Policy Priorities, that $140 billion resulted in covering approximately 30% to 40% of states’ budget shortfalls, and those percentages easily translated into fewer jobs lost and fewer services cut. Unfortunately, there is no indication that the gap between the federal economic stimulus and state’s budget issues is narrowing, which may represent a serious problem, considering that state and local governments account for about 13% of the U.S. total GDP.

At this point, no one knows how things are going to look like on the state level if and when the federal money finally stops coming in. What is clear, however, is that fiscal federalism makes it exponentially more difficult, to the power of 50, to spend the economic stimulus money most efficiently. For example, it is expected that most of the states’ and local government’s stimulus money will go to rural areas, spent on infrastructure. This will leave urban areas, where most people live, shortchanged, creating a dangerous equation in the process if you take into account the fact that the top 85 metropolitan areas in the U.S. haul in three-quarters of the U.S. total GDP.

The discord between federal and states’ fiscal policy is hardly a novelty. However, the fact that this discord is undermining the U.S. recovery mustn’t be ignored. We live in a global economy. The world has become merely a global village. So, how come we cannot create a truly national government? It seems a more achievable task, compared to trying to pull the G20 to work together, for example.