Fiscal Stimulus Does Not Work –Yet We Keep Applying It Stimulus funds are badly used. Capital is wasted, debt grows, and the economy does not benefit

WASHINGTON “If economic troubles are approaching, put together a big stimulus package”. This is the universally accepted prevention/remedy therapy to save any country from the storms of recession or the chills of stagnation.

A good idea?

In principle it sounds like a good idea. If demand is falling, the government will create it through major public spending programs, (infrastructure is a big favorite), and by injecting more liquidity into the financial sector, this way encouraging banks to lend more money.

Well, guess what, it does not work.


In most cases the money spent by governments becomes “malinvestment”. Many new loans become bad loans because, in the rush to promote more economic activities, undeserving, sub par projects get funded. So, when the dust settles, precious capital has been wasted, growth has not increased, while deficits and debt have grown.

If you want a more detailed account of this sad tale of dashed expectations, read How Spending Sapped the Global Recovery, an interesting WSJ op-ed piece, (January, 16, 2015), by Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management.

China’s stimulus did not work

For instance, China, in order to forestall any major contamination spreading from the devastating 2009 US financial crisis, launched a mega stimulus program (12% of GDP)to protect its economy. The problem is that these new funds have often been poorly allocated.

State banks gave money to badly managed State Owned Enterprises, (SOEs). This led, (among other things), to the creation of massive overcapacity in the steel industry that was beefed up in order to produce the material needed to fuel an absurd construction spree.

And now, after all that spending, empty apartment buildings, under-utilized airports and half-occupied shopping malls dotting many Chinese cities provide painful evidence of bad allocation of capital. In the meantime, China did not manage to avoid an economic slow down.

The spectacular failure of China’s stimulus plan should serve as a lesson.

But no. We learn nothing.

We learn nothing

Confronted with stalled economies and frozen political systems that are incapable of promoting the creation of new competitive enterprises, unimaginative government go back to the same, tried and discredited Keynesian medicine: more stimulus.

Abenomics in Japan did not work. But wait, politically victorious Prime Minister Shinzo Abe has the magic powder. How about a brand new $ 29 billion stimulus program? Yes, it sounds like a great idea. In a country with a debt to GDP ratio of 240%, creating more debt seems like a good way to grow out of debt.

And what about Europe? Same story. In this scenario the savior is going to the European Central Bank. The ECB will do the heavy lifting, by buying bonds, this way supposedly revving up the financial sector, by making it easier for (often semi-comatose) European corporations to obtain new commercial loans.

It is amazing how we keep doing the same old stuff, even when the evidence shows that it does not work.

Real growth

Real growth in mature economies is about R&D that produces commercially viable innovation. In time, innovation will translate into increased workers’ productivity and growing standards of living. Of course, we all want economic, fiscal and monetary policies that will not create obstacles to the growth of new enterprises.

But here we have instead the childish belief that propitious monetary and fiscal policies –by themselves– will create innovation and vigorous enterprises. It would be nice if it worked this way. But it does not. Capitalism requires real entrepreneurs. And no, financial manipulations and government mandated investments do not produce solid, wealth-generating corporations.

As Agustin Carstens, the President of Mexicos’ Central Bank, told Sharma, (the author of the WSJ piece referenced above), “fiscal and monetary policy cannot create growth”.

Indeed, they cannot.

Overall, stimulative policies most of the time amount to bad allocation of capital and malinvestment, higher deficits and a larger debt.

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