Austerity, GDP, Debt and Stimulus Multiples

The common wisdom one hears these days is that we are in a hard spot because economic growth is stalling, but government debt is so high that resort to additional “stimulus” via government expenditure is unpalatable.   This is of course only wisdom to the extent that you believe that government expenditure is inn fact stimulative.  What we need according to Paul Krugman and the rest of the Keynesian thought brigade is more such “stimulus”.  Alternatively what you hear from demunists and collectivists everywhere, including Ben Bernanke at the Federal Reserve, is that we must not adopt austere fiscal policies lest GDP be impacted negatively and we are unable to “grow” our way out of our debt problem.

They believe, apparently, that the multiplier effect of a government dollar spent is greater than 1 over the medium to long-term. The reason they believe this is that the way we have chosen to measure economic output and growth is via Gross Domestic Product or GDP.  And GDP is defined thus:

GDP = private consumption + gross investment + government spending + (exports – imports)

See that “government spending” part of the equation? Tempting it is to just ramp government spending and – voila! – you have as much “growth” as you want!  Well hell, why didn’t someone tell us it was that easy?!  Of course it is because it is not that easy.  If it were that easy, you would have discovered the perpetual motion machine, we could all lie around all day fornicating and eating grapes because the government will just spend us up some GDP growth and we will all be fat and happy without having to lift a finger.

How would the government do that anyway?  Well I can think of only two ways the government (which remember is supposed to be us, the populace) can spend as much as they want.  Either you take the resources from someone who has them or you print up some money to spend.  You may object that we can borrow to spend – and we are borrowing to finance this attempted government contribution to GDP at a frightening pace – but that borrowing just represents a claim on future resources that have to be taxed from those who have resources, or will result in printing money to pay off the debts.

If the government relies on the confiscation of resources from the private sector, it should be obvious that total wealth of the society will be less than it otherwise would be as government does not have incentives to spend those resources efficiently.  After living through the last 100 years of political experimentation worldwide, the evidence is in and government allocation of resources does not in fact result in more aggregate wealth than private allocation.  Anyone still arguing otherwise needs to go on the list of those who “just need killing” (see below) as they represent a willful threat to the public safety and welfare.

This leaves money printing.  That too has been tried repeatedly throughout history and the result is inflation or its second cousin, hyperinflation.  Ask someone who lived through the German hyperinflation and its consequences what that does to a society (precious few left now).  Regular inflation is also pernicious as it robs savers and ultimately destroys the middle class.

It is clear then that GDP is a very flawed measure that is leading to absurd policies that are actually destroying our aggregate societal wealth rather than enhancing it.  John Tamny wrote a good piece about it at RealClearMarkets here recently.  First we must have a realistic discussion about the assumed multiplier for government spending and we must agree that it is in fact less than zero.  Then we can discount the government spending element in GDP to reflect its ultimately destructive contribution to GDP.

Having come to the belated realization that the size of government is the problem rather than the solution we can take sensible steps to reduce the size of government and bring down the debt.  What you will find is that contrary to the perceived wisdom, the world will not fall apart, it will heal.  And after some uncertainty, the economy will mend and the standard of living will rise.  If we fail to come to this collective realization, more pain lies ahead.  Austerity is not a curse, to the extent it shrinks the Government, it is a boon.

2 Responses to “Austerity, GDP, Debt and Stimulus Multiples”

  1. Bob Heeter Says:

    “It is clear then that GDP is a very flawed measure that is leading to absurd policies that are actually destroying our aggregate societal wealth rather than enhancing it.”

    There was a time when leaders of both parties understood this and were capable of thinking broadly about what the country really needed, rather than simply parroting the latest econo-speak without understanding the economy’s real, but non-economic foundation. It’s also interesting to see how much inflation and debt-burden has been borrowed-and-spent and printed-and-spent into existence over 43 years, without that much tangible improvement in standards of living and quality of life.

    “And this is one of the great tasks of leadership for us, as individuals and citizens this year. But even if we act to erase material poverty, there is another greater task, it is to confront the poverty of satisfaction – purpose and dignity – that afflicts us all. Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product – if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.”

    I also suspect that both government and private sector spending are prone to colossal wastes of resources due to perverse incentives. So we need to do more than simply miminize government, we also have to make sure that we structure the rulebook for the private-sector correctly. Otherwise we’ll just get more bubbles driven by short-term gaming of the system at the expense of its long-term sustainable health.

  2. t0mmyBerg Says:

    Ah yes, that leads to the other idea I meant to address but slipped my mind. The French either do now or are seriously considering measuring output as a Domestic Happiness Product or something along those lines (and of course there has been half-hearted mention of it here as well over the years). But whereas GDP can be quantified using relatively objective numbers (in theory), the kind of things mentioned by JFK are valued subjectively, meaning everyone can provide a different value and they would not be logically inconsistent. As such that kind of measurement is unreliable as a guide to policy, though certainly people can have a nebulous sense of the general thrust of things. Which is why I restricted myself to tinkering at the margin with the existing formulation to suggest correcting something that is clearly wrong and can actually be fixed – the fact that Government Spending should not enter the equation at face value but should be discounted by some factor which is a representation of the fact that the multiplier is not 1 nor greater than 1, nor probably anywhere close to 1. I suppose you could discount the Private Consumption component as well to account for things like pollution and other such problems that result from economic activity, though I think that is harder than discounting the Government component as it slides toward subjective values again. But your point is well taken nonetheless. Different items that count as contributions to output will not all have the same quality and much that ought to be measured is not.