In response to my statement in a previous post that “you cannot make an economy grow through public spending” there was this touching statement of Keynesian faith:
In terms of a contribution to GDP public spending is as good as any other type of spending.
A dollar of public spending = A dollar of private spending = a dollar of net exports.
How much havoc has been caused in the world by this sweet and apparently innocuous national accounting identity. Yet our economies at the macro level are mismanaged by little else.
So much error, so little time to explain.
First, GDP when first developed was intended as a measure of value adding production. In the end there were a series of rules put in place about how to make the calculation but the problem of the public sector has never gone away. Since most of what is produced by governments has no market test, it was difficult to find a means to calculate with any accuracy the contribution of government spending. So it just went in straight. Whatever a government spent was automatically included as part of GDP, and the more that government spent, the faster an economy would appear to grow.
The result has been that GDP has become a very imperfect measure of value added. Increases in public spending turn GDP into a particularly misleading indicator. A large part of the reason our Government refuses to turn off the “stimulus” spigot is because of the effect it would have on our measured rate of GDP growth. Our economic circumstances would actually improve but the national accounts would show a fall in the level of economic activity.
Second, the Keynesian faith is indeed based on the belief that “public spending is as good as any other type of spending”. I’m not sure that anyone actually believes this any more. But the idea that our scarce resources are being used to put batts into ceilings is “as good as” (whatever “good” happens to mean) the development of some mining site or the construction of a manufacturing plant, is ridiculous. I don’t say that governments never create value, but after the first twenty percent of their total spending, let us say, it is hard to find any addition to our national productivity anywhere in it and many reasons to think it actually makes us worse off. If good means making us a wealthier community, I’m afraid that public spending is, to put it mildly, nowhere near as good as private. How ridiculous to think it is, but there appear to be many in our government who think exactly that.
Third, you cannot take this equation as a straightforward statement of how an economy works. It is, after all, merely an identity. It is true by definition but tells you nothing about the underlying dynamics inside an economy.
The supposed policy that comes from the equation is that if GDP goes down for some reason, say for example a major fall in private investment, I, and this fall in investment leads to an increase in unemployment, you can return your economy to a higher level of GDP by raising the level of government spending, G. Up goes G and therefore up goes GDP and therefore up goes employment.
We are supposedly back to where we were and if you believe that “a dollar of public spending = a dollar of private spending” everything returns to where it was. Except that we have transferred our resources from producing I to producing G. Do I really need to point out that this is not a good trade.
Finally, if you use the equation just as it is, there is no sense of the interaction amongst its various elements. If G goes up there are effects in each of the other components, and there is no reason to think those effects will be beneficial. There are no “all other things being equal” considerations that can be relied on. Crowding out of investment is just one of the many consequences so that as G goes up I goes down. There are also reasons to believe that retail sales are lagging because, with G higher the effect has been depressive on C.
Look at the equation and particularly the X-M. Is there any sense at all to state that if imports go up that GDP will go down automatically and for this reason and for no other? There is no causal connection between higher M and a lower level of GDP. You can provide an explanation but I could easily imagine a rise in imports of capital equipment being used in some investment project leading to a net rise in GDP. You cannot use the elements in the equation taken on their own and by themselves but must have some theory of their interaction.
To use this identity to tell you what to do is the error of errors in economic theory and has brought the world’s economies to the edge of catastrophe. Keynesian economics must go.
I might finally mention for those of you who made it this far that all of this is discussed in my Free Market Economics: an Introduction for the General Reader which will be available from Edward Elgar at the end of this month.