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


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.