Thursday, January 22, 2009

A Heavy Gun Takes Aim At The Stimulus

When people support the stimulus, they will offer up Nobel Prize winning economist Paul Krugman to lend weight to their cause. Well, another heavy hitter came out today in the Wall Street Journal to pillory the Obama Stimulus. Robert Barro, is a Harvard macro economist, and listed as the 3rd most influential working economist based on the number of times his papers have been published in major journals, cited by other major papers, and purchased, according to University of Connecticut Econ Department’s IDEAS ranking. Mr. Krugman, is #15. If you sort by citations alone, Barro rises to 2nd. As a note, when I was in grad school Barro was mentioned quite often, Krugman never that I recall.

Here are some excerpts from his Wall Street Journal piece:

Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called "multiplier" effect of government spending on economic output is greater than one -- Team Obama is reportedly using a number around 1.5.

The explanation for this magic is that idle resources -- unemployed labor and capital -- are put to work to produce the added goods and services. Brian's note - Economist Robert Murphy eviscerates this argument here

If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment. In this scenario, the added government spending is a good idea even if the bridge goes to nowhere, or if public employees are just filling useless holes. Of course, if this mechanism is genuine, one might ask why the government should stop with only $1 trillion of added purchases.

What's the flaw? The theory (a simple Keynesian macroeconomic model) implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.

In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.

…in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory of Employment, Interest and Money." The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936.

Much more focus should be on incentives for people and businesses to invest, produce and work. On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.

I recommend the whole thing, but it's a little dense for the uninitiated.

No comments: