Thursday, April 9, 2015

The Keynesian economist's useless task

Disagreements between different groups of economists often boil down to one group focusing on the short term effects and another group focusing on the long term effects.
"But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again."  - John Maynard Keynes

The GNP is defined as:
  
GNP = C + I + G + X - M

where

C = Private Consumption
I = Private Investments
G = Government Spending
X = Exports
M = Imports 


Clearly if the government simply takes money from one group and gives it to another it does not increase the size of the economy.  So transfer payments are not included in the definition of government spending for calculation of GNP.   However,  if the government pays some people to dig a ditch and then pays them to fill it back in, the defined GNP goes up.  Really this is just another transfer payment that should not be included because there is no real improvement in the economy.  Sadly, much of government spending amounts to hidden transfer payments that don't really increase the size of the economy.   This is like a loophole in the definition of GNP that makes short term statistics support claims that  government spending increases GNP and that austerity hurts GNP.

Keynesians predict that if government spending goes up then the GNP will go up.   By the formula defining GNP, and because the other variables are slower to change, the immediate impact of a sudden boost in government spending is a boost in GNP.   Predicting this increase is too easy and too useless a task.   It is nearly "by definition" and worse, by a loophole in the definition.  In this case, it is the short run prediction that is trivial and useless while the long run prediction  is interesting, hard, and important.   

In the long run, the larger the government is as a percentage of the economy, the slower the economy grows.   The government is an overhead that the productive private part of the economy must pay for one way or another.   They may pay taxes, or loan it money, or pay an inflation tax.   The more economic resources the government controls the less resources are available to grow the real economy.

If you keep applying the Keynesian prescription of more government spending, year after year,  the government keeps getting bigger and the real economy suffers.   Sadly, today Keynesians are the dominant economists and they have been focusing on the short run for far too long.


12 comments:

  1. "If the government pays some people to dig a ditch and then pays them to fill it back in, the GNP goes up but there is no real improvement. "

    You know of course that Keynes had in mind to get money flowing from ditchdiggers and ditchfillers, to elsewhere in the economy, and then from that elsewhere to other elsewheres. And I assume you know that Keynes had in mind to reverse the increase in government spending as soon as the economy was self-stimulating.

    To be sure, the "Keynesians" are not the same as "Keynes". But you quoted Keynes.


    "In the case of GNP, it is the short run prediction that is trivial and the long run prediction that is interesting..."

    Agreed.


    "In the long run, the larger the government is as a percentage of the economy, the slower the economy grows."

    Oh, but that's not interesting. It's only what everybody says, including most of the people in government. But here's the way I remember things: The economy lost its luster. People got concerned that economic growth was slow. They started looking for explanations. They decided, like you, that the size of government is the problem. And they started showing graphs of government as a percentage of the economy. And sure enough, government share was increasing.

    Well, yeah. Economic growth is slow. Therefore, anything that is *not* slowing apace is growing as a percentage of the economy.

    When the real concern is the size of the economy, looking at the size of government relative to the size of the economy is only circular.

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    1. The idea that because the government takes $100 billion from those people and gives it to those other people the GNP goes up $100 billion is just clearly false. Yes, maybe the country is better off but to claim that the GNP goes up for every dollar the government hands out is just wrong.

      I get your point that during a downturn of course the government share of the GNP goes up. That is not what I meant. I have seen studies of 10 year growth rates for countries plotted against government share of GNP and on these it seems clear that countries with smaller government grow faster. Sadly I can't find them at the moment. But it does make sense that over the long run the less overhead that business has to pay in the form of tax, the faster it will be able to grow, right? Now you can well argue that we need some safety net etc, but just looking at the long term growth rate, it does make sense, right?

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    2. "The government is an overhead that the productive private part of the economy must pay for one way or another. " And "it does make sense that over the long run the less overhead that business has to pay in the form of tax, the faster it will be able to grow, right? Now you can well argue that we need some safety net etc, but just looking at the long term growth rate, it does make sense, right?"

      Yes. Cost is always the problem. Excessive income does not hinder economic growth, but excessive cost surely does. But the cost of government is only one of the costs that may hinder growth. Some people point to the cost of energy. I always focus on the cost of finance.

      Cost is exactly what Adam Smith wrote about in Book 1, Chapter 6: Of the Component Parts of the Price of Commodities -- a favorite of mine. In particular, paragraph I.6.18:

      Whoever derives his revenue from a fund which is his own, must draw it either from his labour, from his stock, or from his land... The interest of money is always a derivative revenue, which, if it is not paid from the profit which is made by the use of the money, must be paid from some other source of revenue [that is, from wages or rent]... All taxes, and all the revenue which is founded upon them, all salaries, pensions, and annuities of every kind, are ultimately derived from some one or other of those three original sources of revenue, and are paid either immediately or mediately from the wages of labour, the profits of stock, or the rent of land.

      Smith points to both the cost of government and the cost of finance.

      I'm pretty sure the cost of finance is bigger, and was growing faster until the crisis.

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    3. How do you mean you think the cost of finance is a bigger cost than government? One does not even have to use finance if you don't want and the government is like 1/3rd drain on profits. You can borrow money for a few percent. Not following you.

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    4. Vincent - two words that prove you wrong, assuming that you bother with text book economics - marginal utility. If low marginal utility money is shifted to people for whom it will become high marginal utility money, then the money is likely to be spent productively. If not, it is likely to be spent on an old car - which does very little to increase velocity of money or demand for currently produced goods and services.

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  2. People who work for government do not pay taxes, they merely increase the cost of government. If the government employees someone at 100K, and they pay 40k back in taxes, the government is still out 60k...the real cost (60k) to the government can only come from taxes paid by private sector taxes...so as the government becomes bigger it must increase the burden on the private sector who pay all taxes or borrow massive amounts of money from future private sector workers.

    Government employees also can not add to the GDP, they can only spend money taken by private sector workers, money they would have spent themselves. If anything the government is a drain because for the most part they don't produce anything of value but throw up impediments to the private economy.

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    1. So roads, sewers, water systems, communities, parks and on and on have no value? Please! And does this get done without skilled public employees protecting the interests of the community? Not at all. This notion is absurd and requires a binary level of thinking that is less than infantile. You should be embarrassed to post this inane foolishness. Did you even think it through?

      Let me guess? Libertarian who thinks that there is no such thing as an externality?

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  3. "The GNP is defined as:

    GNP = C + I + G + X - M"

    The equation could also be written as

    GNP = C + I + T + D + X - M

    where T is government taxes and D is new government debt.

    The objection here is that debt is not money.

    Whether debt is money or not, both descriptions of GNP are valid.

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  4. The Yen is on the move again. Slowly but surely...

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    1. From 119 to 124 in less than 2 weeks. It really seems like at some point people holding 30 year bonds paying 1.5% per year and losing more than that per week ought to get panicky.

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    2. I would think so too. Everything looks like it is in place for a feedback loop to start. Yen falls, market moves out of bonds, BOJ buys more bonds to keep interest low, Yen falls more... But for now it's not even two percent annual inflation. For some reason this takes an awful long time to play out.

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    3. But if they are losing 2% per week from the Yen, they have plenty of incentive to get out of Yen denominated bonds, even if inflation has not started yet. Yes, it is taking an awful long time. Interesting to see if it keeps moving this time, or if it will pause again.

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