Rip off the economic Band-Aids and heal the wounds

Regardless of the amount of hair on the subject’s arm, medical experiments on 65 college students published in the Medical Journal of Australia concluded that peeling off a Band-Aid slowly is far more painful than fast removal.

It is nice when science experiments reconfirm what you already knew, what your mother always told you or what you at least suspected.

But, there is an economic parallel to the question of whether to remove a Band-Aid quickly or slowly. The best way to solve most economic problems, so that it hurts the least, is to do what is needed and do it quickly. One sharp quick pain is better than prolonged years of suffering.

Alas, we all want a painless solution. We want to find a pill or Band-Aid that will provide immediate relief. But in the world of economic difficulties, economic potions needlessly prolong the ailment, often delay or prevent a cure, and habitually make the situation worse in the long run.

The housing slump provides the first example of taking the slow-peeling of the Band-Aid approach. Everyone wanted the government, banks or someone to fix it. The Federal Reserve kept interest rates very low to help homeowners refinance loans. First-time homebuyers were given $8,000 to buy houses. Banks were encouraged to modify delinquent loans rather than permit foreclosures.

Yet, we are still suffering a multiyear decline in housing prices accompanied by steadily rising numbers of foreclosures. The actions to try to keep prices of houses up and to avert foreclosures have only delayed the solution to the housing problem. We have suffered a slow-motion painful decline in housing prices that would have occurred faster without the several monetary and fiscal interventions.

We didn’t avoid pain; we just stretched the pain out over more than a few years. The delays have led to a staggering number of empty houses in Nevada, Arizona, Florida and elsewhere. They hang about for years in foreclosure limbo extending the housing problem.

The second example looks at the recession that began in December 2007. While that recession is officially over, most of us feel like it isn’t. A recession is painful. We want it fixed. We want it fixed now!

The government has used almost all of its usual tools of monetary easing and fiscal stimulus, in particular, the $787 billion stimulus package. Since a large portion of the stimulus package went to repair State’s budgets, much of the stimulus went to pay for already planned capital projects or for already budgeted items.

If a project was already being worked on, and the fresh money from the federal government comes in to pay for it, there is no net stimulus that increases job creation. It is hard to find jobs created in a stimulus when the total number of unemployed workers has increased.

Now with the stimulus money gone, state and local projects are being scaled back to reflect lower state and local income in a weak economy. Accordingly, the stimulus merely delayed the impact of the economic slump on public employment rather than solving the recession problem. Public employees will see the largest percentage increase in unemployment of any group in 2011.

The recent decision to release millions of gallons of oil from our Strategic Oil Reserves is yet another short-term economic palliative. It will lead to lower prices for gasoline for a week or two, but this policy is not a long run solution to unemployment, slow GDP growth, or our energy dependence on oil. It is just another economic band-aid that will only lead to higher prices in the months when the oil reserves are replenished.

There are many other examples of economic policies that started out with good intentions, yet ended up hurting those it was designed to help as the program expanded. Surely, 13 weeks of unemployment compensation is helpful to someone who is unexpectedly fired; however, extending unemployment payments to 99 weeks increased the average duration of unemployment. The unintended consequence is that the incentive to find a job immediately is reduced, so we find people stay unemployed longer. By lengthening the time in unemployment, we sabotage the unemployed workers’ marketability for the next job.

Similarly, many agricultural subsidies began with righteous goals of raising farm income for small farmers; inevitably large firms garner the lion’s share of the benefits thereby unintentionally subsidizing them to buy out the small farmers, who we wanted to help.

We stand at a time of high unemployment and GDP growth just below 2 percent. We want to “fix” the problem with more monetary and fiscal stimulus. The desire for a Band-Aid or palliative is growing. Yet¸ further monetary stimuli could lead to inflation injuring all who are hoping their retirement savings will outlast them. Or we might try further fiscal stimulus packages through more capital projects or more grants to states, but these have not proved to be effective in reducing the unemployment rate. They have only worsened a growing budget deficit.

The Hippocratic Oath says never to do harm. We are seeing that much of our economic palliatives and potions are ones that do not heal, do not alleviate pain, and cause lasting harm. A Band-Aid pasted over a bleeding wound is typically ineffective and merely cosmetic. We need to clean the wound, stitch it up, and get on to real business of healing.

We must avoid short-term Band-Aids. We must face up to the intense, short-term adjustment pains as we get our federal and state budgets back in balance. Longer run healing will only begin when we act decisively to address the problem and not to rely on Band-Aids.

Richard  Marcus is an associate professor of business at the Sheldon B. Lubar School of Business of the University of Wisconsin-Milwaukee.

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