Wednesday, October 21, 2009

Why government spending doesn't stimulate the economy

Veronique de Rugy explains it very simply in an article in Reason:

Overall, government spending doesn’t boost national income or standard of living. It merely redistributes it—minus the share it spends on the bureaucracy that collects and spends our tax dollars.
The vast bulk of the "stimulus" spending that Washington has cranked up won't do anything to stimulate the economy, as I and many other economists have argued all year long. That's because almost all of the stimulus spending is essentially a transfer of money from one person to another, while a small fraction is going to be used to actually build new infrastructure (and most of that won't happen for a long time). The only kind of stimulus that makes a difference is the kind that focuses on changing people's behavior. Tax income less and you will get more work; tax capital less and you will get more investment; tax saving less and you will get more saving. 

Will someone please explain this to Mrs. Nancy ("Clueless") Pelosi as she flirts with the idea of yet another stimulus package? 


Bret said...

That is certainly true if the economy is at full employment.

It's not inherently true at higher levels of unemployment if the government spending employs those who would not otherwise be employed to do something productive.

Public Library said...

Another good post. Someone stop the misguided bailout/stimulus efforts!!!

jeff said...

Scott, don't assume that Pelosi/Obama actually want to grow the economy and just haven't tried the right thing yet.

It is rather clear they want to redistribute wealth. With government taking it's cut of the action.

Scott Grannis said...

Bret: You assume that the government (in this case congresscritters like Nancy Pelosi) can find productive (and therefore profitable) things for idle resources to do that the private sector has overlooked. I'm not willing to go that far. You are also presuming that congress can spend money productively, and I while there are certainly some examples of that happening, I think they are the exception to the rule.

Bret said...

Scott: The government needn't find "profitable" things for idle resources which is the big advantage they have over the private sector. For example, the private sector is constrained by both needing to be profitable and paying minimum wage which precludes potentially a great deal of employment. The government needs only pay minimum wage and as long as they get some value out of those they employ, whether or not via private companies, the nation is still better off than if those people are completely idle.

In other words, the government can simply overcome the burdens of taxes and regulation by paying more than it would otherwise be worth to the private sector. Obviously, it would be much better to reduce the tax and regulatory burden, but since that won't possibly happen, it's immaterial.

Now, I do agree that at this point this government will likely end up diverting and squandering more productive resources than it manages to employ from the otherwise idle pool of labor. I just don't think that it's inherent in all cases as you seem to imply in your post.

Mark A. Sadowski said...

Alas, somebody forgot to tell the economy that discretionary fiscal stimulus doesn't work.

After falling considerably, and progressively more deeply in each of the three quarters before the most recent one, the fall in GDP moderated substantially. After declining at an annual rate of 6.4% in the first quarter of 2009, it fell at a rate of 0.7% in the second quarter. The rise in GDP growth from the first quarter to the second was the largest in almost a decade, and the second largest in the past quarter century.

This sudden change of fortune was not the result of any change in monetary policy or TARP. We have been in ZIRP since December and the Federal Reserve's balance sheet has been more or less constant since then. TARP was actually unwound to the tune of over $400 billion during the last two quarters. The only new discretionary economic policy that went into effect over the past several months was the fiscal stimulus that has been spent (direct spending plus tax expenditures) at the fairly constant rate of $100 billion a quarter the last two quarters.

Econometric analysis performed by Moody's, Macroeconomic Advisors, Goldman Sachs, J.P. Morgan Chase, IHS/Global Insight and the Council of Economic Advisors (CEA) credit the stimulus with adding 2.8%, 2.1%, 2.2%, 3.0%, 2.3% and 2.3% respectively to GDP growth at an annual rate in the second quarter. The average of these six vector autoregression analyses (VAR) is thus about 2.5%. These same private firms and insitutions are predicting that the stimulus will add 3.6%, 1.9%, 3.3%, 4.0%, 2.3% and 2.7% respectively to GDP growth in the third quarter compared to baseline or an average of 3.0%. As a result GDP will be about 1.4% or $200 billion higher at an annual rate in the third quarter thanks to the stimulus.

In addition Moody's, Macroeconomic Advisers, IHS Global Insight and the CEA using VAR analysis project that the stimulus will raise employment by 1,070,000, 620,000, 690,000 and 1,040,000 respectively or an average of 856,000 in the third quarter over baseline.

I remind you that I'm not opposed to supply side economics by any means but like founding figure Bruce Bartlett I believe economic policy should depend on the nature of the problem. I found this recent article by Bruce to say precisely what I believe:

Scott Grannis said...

Mark: Bruce Bartlett is no longer a supply sider, and I found his article to reflect a disappointing lack of understanding for how the economy really works. I continue to believe that the "stimulus" bill actually hurt the economy by sharply raising future expected tax burdens. All the models you cite assume that government spending has a multiplier of 1 or more, but I find that assumption woefully lacking in common sense.