The negative multiplier effect defined

Byline: | Category: Above the Fold, Economy, Government, Taxes & Spending | Posted at: Wednesday, 9 October 2013

Economists like to talk about the multiplier effect of government spending.  The theory is that if the government spends a dollar buying products, services, or even spending it on welfare, the money is transmitted through the economy many times over when the original recipient buys things which then put extra money in the pocket of another recipient, who then buys things, and so on.

Keynesian estimators of the multiplier effect often focus on the spending and thus only predict a positive multiplier.  This, however, analyzes only one half of the equation:  ”that which is seen,” in the words of Frederic Bastiat.  That which is unseen is where the money came from. In the case of government spending, it can only come from higher taxes, meaning that someone else is unable to spend himself that which the government spent, or from higher borrowing, meaning that someone else in the future is unable to spend the amount of money borrowed plus interest.  The multiplier effect, therefore, can only be positive when viewed through the double entry accounting method, if the government spending today has a higher multiplier than the multiplier effect of private spending, whether today or in the future.  Depending on their political stripes, economists latch onto data that buttress their belief that government spending is more or less efficient than private spending.

Today comes data that point substantially in the direction of anti-Keynesians who argue that government spending is a bigger drag on the economy than if the spending decisions were to be left in private hands.

Senator Sessions Debt GDP Chart

The ranking member of the Senate Budget Committee produced this chart showing that over the last two years, the government added $2.4 trillion in debt and saw GDP increase by only $1.2 trillion.  Keep in mind that government spending is part of the equation used to calculate GDP.  So this chart implies a negative multiplier of 50%–meaning that for every government dollar spent through debt, the economy shrank 50 cents.  Even if we were to use the pre-2009 deficit of $400 billion a year as a baseline, this would mean that the extra government deficit spending of $1.6 trillion over the last two years resulted in a GDP increase of only $1.2 trillion and a negative multiplier effect of 25%.

No company in the world would borrow money if they expected a negative return on investment as this chart implies.  And yet we are told again and again that the economy will collapse if we don’t extend what is clearly counterproductive deficit spending.

MORE:  This chart dovetails nicely with John Tamny’s column from yesterday:

“First off, there’s no such thing as fiscal stimulus of the spending kind. Though it’s well known at this point, governments can only spend money they’ve first taken from the private sector. In short, governments can at best merely steal demand from certain economic sectors in order to fund generalized waste and a bigger state. There’s no economic growth to speak of, rather there’s decline.”

Read the whole thing.

UPDATE:  Thanks to John Tamny’s RealClearMarkets for the link.  While you’re here, take a look around.

Share this post:

3 Responses to “The negative multiplier effect defined”

  1. Windriven Says:

    “So this chart implies a negative multiplier of 50%–meaning that for every government dollar spent through debt, the economy shrank 50 cents. ”

    One can infer that conclusion only if one believes that had the government spent nothing through debt that GDP would remain unchanged. The fact is that the US is recovering from a deep recession marked by very soft demand.

    Borrowing from Mr. Tamny: “There’s no economic growth to speak of, rather there’s decline.” It is arguable that absent federal deficit spending the decline would have been steeper and deeper.

    Ed: Your argument is that things would have been much worse had we done nothing, the corollary of which is Krugman’s “we didn’t borrow and spend enough” argument. There are two problems with that argument. The first is that it’s a non-falsifiable and therefore, scientifically untestable assertion. The second is that, let’s just for the sake of argument assume that if things had been left alone–if deficit spending had remained at its heretofore record level of 400 billion dollars a year, then over the last two years government spending would have been $1.6 trillion less. If we presume a positive multiplier of 1.5, you’re asserting that by taking away $800 billion of government spending we would have seen GDP drop by $1.2 trillion in each of the last two years.

    For that to be true, we should probably specify where the $800 billion would have been cut from the budget. If it were cut out of 2-year extensions to unemployment benefits and the doubling in the number of those on disability benefits, then for you to be correct, the lost welfare benefits and their downstream multiplication would not have been overcome by the addition of more people into the workforce who, because they weren’t eligible for welfare, were forced into taking a productive job. This doesn’t seem likely.

    How about if we took away spending on the F35 jet fighter program? For you to be correct, the aviation industry would simply have dwindled to nothing instead of diverting resources, labor, and capital to civilian aviation pursuits. Because the government instead consumed those resources, they weren’t available for productive uses–which instruments of war definitionally are not.

    So essentially the argument that GDP would have been even worse absent gobs of government spending is that the government is a more efficient allocator of resources. $600 million spent on a health care website that doesn’t work is an all too typical example that this is not so.

  2. Windriven Says:

    “Your argument is that things would have been much worse had we done nothing…”

    No. I said the point was arguable. I personally believe that the money was ill-spent and did little more than enrich those most complicit in precipitating the recession. But I also believe that in a recovery stalled by weak demand, government stimulus is appropriate. The notion that cutting taxes or reducing regulation would have similar effect is, in my opinion, bogus. I own two manufacturing companies and I know damned well that businesspeople do not hire or spend or ramp up production until there is demand on the horizon. In fairness, the author did not offer that alternative. But it is the standard trope of those generally opposed to government stimulus.

    “The first is that it’s a non-falsifiable and therefore, scientifically untestable assertion.” And that is part of my objection to the inference you draw from the chart. The chart is interesting. But it does not necessarily mean what the author claimed.

    Ed: I apologize for misunderstanding your offer of a devil’s advocate position as advocating that position.

    But your follow-on assertion is interesting:

    “I personally believe that the money was ill-spent and did little more than enrich those most complicit in precipitating the recession. But I also believe that in a recovery stalled by weak demand, government stimulus is appropriate.”

    It sounds like the argument is that the additional government spending was technically counter-productive, but as it offered the illusion of greater aggregate demand, its placebo effect was necessary. Interesting.

  3. Zeke Says:

    I think three things favor private spending over government spending, regardless of when:
    1. private companies are on the whole more efficient allocators of capital. I don’t know that this can be proved to all conclusively, though I know there are studies, but just use common sense; in the private sector there is competition, whereas the government is a monopoly actor.
    2. the keynesian theory of govt spending during recessions, and reducing spending during expansions, as a practical matter only happens in the former situation.
    3. related to #2: govt spends money in a partisan spoils manner.
    4. (oh I said 3): why is it that it should be desirable to smooth out GDP?