Tuesday, October 6, 2009

Demons, Dragons and Eclipsing Recessions

Many ancient cultures believed that solar eclipses were the result of a dragon or some other demon trying to devour the sun. Since the loss of the sun would be catastrophic, community members would often perform some ritual to either drive the demon away or help the sun fight back. In China, we are told, people would bang pots and drums to try to frighten the dragon away. In India, they would immerse themselves in the local river to help the sun fight off the dragon. These, and other practices, were always successful at bringing the sun back. Better still, they worked quite quickly and were likely reasonably cheap to perform.

Of course, today, we know that the solar eclipse has nothing to do with dragons or demons and that the rituals the ancient people performed had nothing to do with the sun’s return. We enlightened moderns scoff at such silly beliefs and rituals. In economist-speak, we know the difference between correlation and causation; that is, the sun’s return may have occurred as the ritual was being performed – the sun’s return is correlated with the performance of the ritual – but the sun did not return because the ritual was performed. Unlike people in the past, we know that the sun would have returned regardless of whether or not the ritual was performed. The ancient people, of course, didn’t really want to take that chance. The rituals were cheap to perform and, no doubt, by the time the community had noticed that the eclipse was happening and had assembled for the performance of the ritual, it wasn’t long before the sun was returning. Why risk the chance that the sun would never come back?

There are many others cases throughout history in which correlation and causation are confused. The patent medicine vendors and snake oil salesmen of the eighteenth and nineteenth centuries profited from this confusion. The concoction of alcohol, water and herbs sold as a cure for “what ails you” had no curative properties whatsoever. However, by the time the patient felt ill enough to use the foul-tasting mix and repeated its use for the prescribed amount of time, the illness had gone away: correlation not a cure.

In the twenty-first century, we have banished dragons and demons from the natural world; however, we have not banished them from our lives. A modern demon that obsesses us today is the economic recession. All of us became aware of this demon devouring our wallets and portfolios about a year ago. To drive the demon away, we didn’t bang pots and drums or submerge ourselves in rivers; instead, we relied on government stimulus packages for the cure. Much as in ancient times, the community leaders are now all declaring these packages to have been successful. While the recession dragon hasn’t gone completely, it is receding. With continued stimulation, it will be gone for good.

The question is, of course, is all of this causation or correlation? In a system as complex as the global economy, it is never easy to sort out causation and correlation. Further, accurate data on stimulus spending is not always easy to find. As the Canadian Parliamentary Budget Officer notes, it is difficult to tell how much of the infrastructure money in the government stimulus package has actually been spent. The suspicion is that little spending has actually occurred yet. In the US, information from the recovery.gov webpage suggests that about $35 to $40 billion of infrastructure monies in the US stimulus package have been spent. The relatively modest amounts of infrastructure spending to date make it difficult to believe that many jobs have been created or that this spending has pulled these economies out of recession. Of course, politicians, like the ancient leaders and patent medicine vendors of the past, are more than happy to take credit for the recovery. Stimulus has worked!

If stimulus spending has not caused the recovery, we need to ask how this happy correlation between stimulus packages and recovery occurs. The explanation is this: It typically takes quite some time for all of us to notice that a recession has occurred. In the current recession, it was almost a year before the seriousness of the economic downturn became apparent. Once the recession is identified, political leaders and policy makers require time to formulate their policy / stimulus package and pass the legislation authorizing the spending. Further time passes while a bureaucracy is set up to approve projects and distribute stimulus money. Once the stimulus money begins to flow, so much time has passed that, for reasons completely unrelated to the stimulus spending, the economy is already coming out of the recession. It’s much like the patent medicine that “cures” your illness. Like the patent medicine vendors, political leaders declare victory and we go on believing in the importance of stimulus spending for fixing recessions.

Not surprisingly, politicians today, much as the leaders of old, don’t want to risk not stimulating the economy. After all, the stimulus money is not theirs and any perceived delay in economic recovery is politically costly. Unfortunately for all of us, the cure for driving away the recession demon is not an hour or so of our time spent banging drums or wallowing in a river. For the tax payer of Canada the cost is tens of billions of dollars; for the taxpayer of the US, it’s hundreds of billions of dollars. No cheap cure, that.

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