Multiplication and economic growth....

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Tim Worstall reminds us that there's something of a problem with the Keynesian multiplier:

And if we look closer at this, and we find that the relationship is actually only one to one, then we’ve a disproof of the central Keynesian contention. Which is that a rise in government spending (when in recession, when there’s unused assets lying around) increases GDP by more than the increase in government spending. We were certainly in recession, government spending certainly changed, but if GDP only changed by the amount of spending change then that’s a disproof, not a proof, of the central Keynesian claim. 

But the myth is widespread - if you look at the work of many in the field of local and regional economics, the idea of the multiplier is absolutely central to the presumed effectiveness of the policies they propose. Now I appreciate that Worstall is making a different point (essentially the arithmetic is just arithmetic never scientific proof - the biggest problem with much of macroeconomics) but we still need to remind ourselves that the multiplier is something of a myth. It's a myth when it's observed that government spending increases GDP by the amount of government spending (i.e. there is no multiplier) and just as much a myth when it's used to justify some sort of localist quasi-protectionism or that government procurement contributes to economic growth.

My concern is that this approach to public spending results in more expensive local services (the only reason for the quasi-protectionism is that non-local supplier may be cheaper) without any real evidence - other than arithmetic - that there is any economic benefit to deliberately making prices higher. Indeed, most of the time in economics we'd rather prefer prices to be stable and not determined by the arbitrary (or protectionist) choices of government.

The same applies for the local high street. Because supermarkets are more efficient, their prices are (mostly) lower than the prices in the precious independents on the high street. If we regulate and tax so as to penalise supermarkets for being more efficient all we do is to make prices higher for the consumer. And because such price rises fall most painfully on the poorest, such regulation and taxation is highly regressive (rather like duty on booze and fags - but that's another story). All those trendy folk talking about 'resilience' and 'sustainable high streets' are, when you boil it down, calling for the prices of basic everyday goods to be higher so the greengrocer on the high street isn't undercut by the supermarket.

Thus, to return to the multiplier, any benefits that might come from money circulating more in the local community are more than absorbed by the higher prices. And this is before we consider the opportunity costs of government spending. We simply can't presume that simply spending the money has more economic impact than either lower borrowing or lower taxes (or both). As has been observed:

"From where to people find the means to purchase consumption goods, other than production?"

Even if we accept that there is some local impact, it is limited by several factors (ones that NEF ignore in their LM3 model). Since the biggest cost for most businesses is wages, we have to start by noting that around 40% of that cost go straight back to the government in tax. And, after this, other significant costs - utilities, fuel, transport - aren't retained within the local community either. If our assessment is on consumers then we should note that their biggest costs (tax, rent or mortgage, utilities and transport) aren't retained locally. What the advocates of local multipliers are arguing is that the economy will be transformed by the redirection of part of the cost of groceries - in reality this is an utterly insignificant effect even assuming inefficiencies haven't wiped out any gain.

At the heart of all this work is a keen urge for the public sector to feel it is contributing - by its very existence - to economic growth and not just on a pound for pound basis (which isn't really growth) but as a stimulus to the economy. The problem is that, between protectionism and opportunity cost, any benefits that might arise from the multiplier are lost - and this assumes there are such benefits in the first place.

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Austerity and government spending

Austerity is back in the news. Not that it ever went away, I guess. But it's back, the IMF has told us that we're too austere (thereby contradicting what it said the previous time and the time before that) and the masses hordes of pseudo-economics experts has leapt on the collected words of a few luminaries to say that the government needs to do something different.

They are, however, studiously vague about what that "something different" might look like. One day it sounds like printing loads of lovely pounds and scattering them like confetti across the nation. Later the same folk suggest - in the manner of business snuggling up to government - that we should "invest in infrastructure" with that freshly created and unearned cash.

Mostly though the cries of pain around "austerity" are about government spending rather than economic growth. Sometimes this is wrapped up in barely understood, quasi-Keynesian comments about aggregate demand thereby providing cover for a message that tries to tell us that the answer lies in borrowing more money to spend on (variously) higher benefits, new trains, tunnels under London, "boosting the housing market" and any number of special appeals from health and welfare lobbyists.

The central argument is that the problem is that we (consumers) aren't spending enough. Which is a bit rich when the government insists on taking round-a-bout half of all we earn so it can squander it inefficiently on heaven knows what. Plus of course the rest of the government's strategy - cheered on by the austerity worriers - is to inflate our way out of debt. For sure, we pretend that the high inflation of the past four years has been brought about by special factors but the truth is that the Bank of England, charged with controlling inflation, has been allowed to ignore its responsibilities by allowing that inflation to run well above the target level month in and month out.

Since the government hasn't really cut spending then we have to ask where the austerity comes from? It's a real fact that there are people out there who are more-or-less destitute - the latest reports from those food banks (for all their selective nature) tell us this is so. But are those people destitute because of government spending cuts - spending cuts that, in aggregate, haven't happened? Or are they destitute for some other reason - policy, regulatory or just plain bad luck?

It seems to me that, by focusing on the misguided view that the cure to economic problems lies with government (and central bank) action, we condemn many people to a much deeper 'austerity' that would have been the case had we focused instead on the things that do make people better off, that do end recession and that do prevent "austerity".

Growth comes from adding value - taking or doing things that make lives better, that allow us more time or that give us access to things we didn't have before. It doesn't come from taking money off Fred and giving it to Susan. It doesn't come from regulation, from controls or from the deranged view that a few suited masters in the Treasury can "run the economy". Every day I see exciting, creative people doing things to make the world better and brighter - sometimes just because they care but mostly because they can turn that value into money and that money into nice cars, foreign holidays, fancy clothes and a big house.

That's what will end austerity not government spending.

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