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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Local multipliers are something of a myth

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Trendy regional economic development folk like to tell you about "the multiplier effect" arguing that buying locally means that more money "stays in the local economy". We are told - mostly without any real evidence - that this multiplier effect is the magic formula for making poor communities less poor, that it explains how paying higher benefits improves local economics and is the reason why inefficient traditional high streets are better than supermarkets.

Here's an example of this mythmaking from New Start magazine:

Working with the Centre for Local Economic Strategies, Preston Council is researching how much of the procurement spend of institutions – including Preston College, the University of Central Lancashire and Preston Council itself – actually stays in the local region.

‘The findings so far suggest that each institution spends less locally than you’d expect’, Whyte says. ‘There’s scope for us to improve that by looking at how to maximise local spend and supply chains and if there are any gaps in the local market, think about what we could do to fill it.’

The Evergreen model fills those gaps through a network of co-ops supplying food, energy and laundry services to local institutions. Preston Council is considering emulating this approach and has undertaken a number of initiatives to boost and expand local coops, including setting up a Co-operative Guild network.

Sound great doesn't it? But what it covers up is a fundamental factor about local preference - it distorts the market and, in doing so, it raises prices. If local suppliers in Preston know that they won't be squeezed out by a supplier from distant Burnley or, god forbid, Skipton then there will be no need for them to keep prices under control.

Thus we witness the essential fallacy of the local multiplier - the gain made in keeping money circulating locally is taken up in higher prices. It is, at the local level, essentially protectionism - great for the businesses that benefit but awful for the consumers who don't. The money may be circulating for longer but the buyers are paying more than they would be if the system were a free market. There is no gain.

And this is before we start talking about the opportunity cost of public spending:

It is quite misleading to leave public policymakers with the notion that their spending is not at the expense of the private sector because it may be autonomous or have multiplier effects

There may well be a local multiplier but these strategies to promote it are not only ineffective but probably damaging to the local economy (and certainly an impost on consumers).  Apparently though, this is "new economics" and we should be excited:

Until recently experiments in local economics were small-scale and peripheral. But the failures of orthodox approaches are leading even the most successful local economies to find new ways to boost jobs and revitalise communities. With a paucity of ideas and support from central government local areas are now abandoning laissez faire for more interventionist approaches.

Welcome to the latest in a long line of failed and failing regeneration strategies!

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I wish Bristol well with their 'pounds' but it won't work

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I'm a big fan of alternatives to money. Especially in this age of governments debasing the currency year after year and pretending it's all for our good (rather than as a favour to their pals in banking and property development or to cover up their past mistakes). So the Bristol 'pound' sounds like a great idea - here's the BBC bigging the idea up:

More than 350 firms in the city have signed up, making it the UK's largest alternative to sterling. Unlike previous schemes which have relied on paper, the Bristol Pound can be used online, even by mobile phone. 

So that's progress. The problem is that the motivation for the introduction of the Bristol Pound isn't escape from the tyranny of state controlled money but a rather righteous desire to 'keep more of the money in Bristol'.

"If you lock the money into the area, rather than it going into the international finance system then you keep more money actually working in the city here."

This is - in effect - an attempt to game the local multiplier. But the problem with the Bristol Pound is that there's not incentive to play. For sure, the trader (or other user) is locked in because there's an exchange fee of 3% to turn Bristol Pounds into Sterling. So why should the trader go to the bother of converting real pounds into Bristol 'pounds' knowing that there's a built in loss and there are only 350 businesses who will accept them. Businesses that don't include any suppliers outside Bristol.

When we look at successful alternative currencies they either fill a real need (for example Linden dollars in Second Life) or else contain a strong sales promotional element. The Bristol Pound would have a lot greater consumer purchase (if you pardon the pun) it it offered discounts at the 350 businesses rather than simply trying to pretend that there really is a "local multiplier effect" and you can game it with a make believe currency.

I hope I'm wrong - perhaps Bristol Council (I'm guessing it's the City's biggest employer) will offer pay rises to staff only if they take them in Bristol Pounds. Or perhaps offer an incentive on personalisation payments for social care - 110% of value if 20% is taken in Bristol Pounds. If something like this happened then there's a chance that the new currency will work. Otherwise it will splutter and struggle on without really making much of a difference in the City.

Finally the lesson from LETS type currencies is that you need a big area - the successful Chiemgauer system covers the whole of Bavaria for example.So the whole of the South West is a better basis for success than just the fine city of Bristol.

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