Let’s Have a Constructive Discussion (Updated)

In the Wall Street Journal this morning economist Robert Barro questions the effectiveness of fiscal stimulus:

I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports — personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses — there was a dampener, rather than a multiplier.

We can consider similarly three other U.S. wartime experiences — World War I, the Korean War, and the Vietnam War — although the magnitudes of the added defense expenditures were much smaller in comparison to GDP. Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 — the same value as before. (These estimates were published last year in my book, “Macroeconomics, a Modern Approach.”)

There are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases. For one thing, people would expect the added wartime outlays to be partly temporary (so that consumer demand would not fall a lot). Second, the use of the military draft in wartime has a direct, coercive effect on total employment. Finally, the U.S. economy was already growing rapidly after 1933 (aside from the 1938 recession), and it is probably unfair to ascribe all of the rapid GDP growth from 1941 to 1945 to the added military outlays. In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.

To decipher the econ-speak if a stimulus plan has a multiplier of 1. that means that it has no effect on GDP since every dollar in increased government spending is balanced by a dollar of decreased private spending with no net effect on GDP. If a plan has a multiplier greater than 1, it means that for every dollar of increased government there’s more than a dollar’s worth of effect on the GDP. So, for example, if the multiplier is 1.5, for each dollar’s worth of spending, GDP increased by fifty cents. If the multiplier is less than one, then the measure would actually reduce GDP. Or at least that’s the way I understand it.

Apparently, the Obama Administration has been working under the assumption that the Keynesian multiplier is 1.5.

As regular as clockwork Paul Krugman responds:

Actually, I’ve already taken that one on. But just to say it again: there was a war on. Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort.

Oh, and the economy was at full employment — and then some. Rosie the Riveter, anyone?

I can’t quite imagine the mindset that leads someone to forget all this, and think that you can use World War II to estimate the multiplier that might prevail in an underemployed, rationing-free economy.

What gripes me about this discussion is that everybody wants to argue the negative, picking holes in the opponent’s argument; nobody wants to make an affirmative case.

In order to have a really constructive discussion advocates for a fiscal stimulus package need to make an affirmative case, showing and supporting their claims. That’s the rule: the burden of proof is on the affirmative. That, of course, is why everybody wants to argue the negative. It’s so much easier.

I don’t doubt that an affirmative case can be made; I just haven’t seen one. Recently, whenever I’ve seen an argument for a multiplier of this or a multiplier of that, I’ve followed all the references and so far I’ve seen little but unsupported claims or ceteris paribus statements.

It’s time for reputations to go on the line. Make the argument. Support the claims.


Matthew Yglesias makes a point that Megan McArdle has made from time to time, namely, that there may be diminishing returns to scale in a fiscal stimulus plan:

World War II spending was enormous relative to GDP. Wartime spending on that kind of scale goes way beyond the conversations we’re having right now about fiscal stimulus—the equivalent today would be something like a $5.2 trillion package rather than the $800 billion or so we’re talking about. And to get spending up to that level the government had to resort to quasi-forced savings (”war bonds”), rationing, etc.—deliberate efforts to direct production away from where demand was highest and toward the national objective of military production. The 0.8 multiplier is probably the result of diminishing returns. The question is whether you got a decent multiplier out of the first 5-10 percent of GDP you spend on stimulus.

A change from a multiplier greater than one to one less than one isn’t just diminishing returns to scale. It’s negative returns to scale—becoming counterproductive.

Are there diminishing returns to scale? At what point does that occur? $5.2 trillion? $800 billion? $100 billion? These aren’t questions that can be settled on the basis of pure reason. I want to see the data.

8 comments… add one
  • Brett Link

    We need to know more in specific areas. We need to, for example, figure out whether or not federal spending “crowds out” private investment, and what that even means.

    I mean, ultimately investors are buying these Treasury Bonds which finance American deficit spending, and I’ve seen no indication that that money would have gone to a private investment with a higher return – Treasury Bonds are all about security.

  • Krugman and Yglesias both ignore two points that Barro made: First, he analysed three other wars other than WWII, and in aggregate they returned the same number as WWII. Even with weighting that suggests the other three must have averaged out to about the same 0.8 multiplier that WWII delivered by itself. (If the weighting is too great for WWI the results of the other three wars might not matter.) The same argument to dismiss the WWI numbers won’t work for WWI, the Korean War and the Vietnam War. We need two additional pieces of information: What were the multipliers for the other wars, and what wieghting method was used. As it stands I can’t put much faith in what any of them are saying.

    Secondly, Krugman and Yglesias completely ignore the Barro’s point that Keynsians have been claiming that the massive spending for WWII ended the Depression. That massive spending can’t be a drag AND a boost at the same time, although that seems to be their argument. They either need to show that the ‘Keynsian’ argument for the end of the Depression actually hasn’t been made by economists, or come up with another explanation. By simply not addressing this assertion they seem to be accepting Barro’s argument on that point.

    Clicking through some of the links I saw that one of Krugman’s commenters DID argue this point in a previous post. The point was that the WWII spending was a stimulus to greater growth post-WWII (and post-WWI) because of greater returns down the line – the true point in investing. But even if true, that case needs to be made. How do we know the post WW booms weren’t simply from the end of the drag that was war-time spending? And did investment in the manufature of bombs, tanks, etc really lead to a post-WW boom? I believe that the US ramped down defense spending rapidly after both wars. Was it that easy to convert all the factories to peacetime spending? Was it that easy to reintegrate all the retunring soldiers?

  • I’ve read arguments that it was the enforced private saving during WWII that ended the depression rather than the increased government consumption.

  • Brett Link

    I’ve heard that one too, Dave, although was it actually forced spending, or just rationing creating that type of effect? The story I heard about it was that because of rationing, Americans didn’t really have a lot to spend their money on, so they piled it up in savings – and spent once the economy de-mobilized.

  • Drew Link

    Brett –

    Crowding out has not occurred, as the textbooks said, because countries like the Chinese or Japanese have bought our Treasuries and held down the general interest rate. They have done this as the natural result of their low consumption/export/high saving policies.

    However, this does say anything about the relative return on or wisdom of government expenditure.

    However, many net saving countries and companies have desired and have in fact made huge investments in the US the last 30 years – “buying up America” you know – demonstrating the obvious attractiveness of investment in the private sector.

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