James Hamilton points to a paper by UCSD colleague Professor Valerie Ramey on the effects of government spending from a forecasting perspective. Here’s her conclusion:
Using a variety of identification methods and samples, I find that in most cases private spending falls significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity.
That finding is certainly consistent with the various empirical studies which have found little or no net economic stimulus as a result of increased government spending.
My guess is that the folk and neo-Keynesians, still clinging bitterly to increased government spending to cure what ails our economy, will merely dismiss this finding when what they should be doing is producing evidence of their own, something they’ve been reluctant to do.
So can I send the Hey Norms of the world over here to watch the veins in their necks bulge?
Seriously, thanks for posting. I had seen this even though I visit econbroweser much less frequently as I find Menzie Chinn increasingly tedious and clinging to erroneous predictions from 2-3 years ago. But I’ve always got time for Hamilton.
The obvious question is why? My personal view is along the lines I’ve cited for years: government spending in aggregate is inherently less productive than private. A less efficient machine for what I think are clear reasons. And there are just only so many resources to go around.
So imagine this little thought experiment. Lets stipulate that there are certain technologies, applications and potential served markets for solar energy. But we all know about the big government sponsored flops recently. Said another way, government is a big, sloppy and irrational competitor for ventures a private investor/businessman might find attractive. Would you step in front of that freight train in an effort to see your narrow efforts squashed?
Alternatively, the quip I always use in investment discussions at the firm is that I don’t like industries with government participation, “because I don’t want to wake up some morning and read in the Times that some politician has put me out of business.”
The results of Ramey’s statistics are not exactly mind bending if you are in the cauldron.
It depends. If you’re extremely confident that no matter what happens, the federal government is unlikely to allow the particular industry to fail and come what may will always shovel more money at it, it’s the most secure investment in the world. It’s like found money. That’s how I think that healthcare and banking are being perceived these days.
One of the reasons why is probably “poaching.” Public spending on the stimulus has been shown to have resulted in hiring skilled workers away from private sector jobs without creating new jobs.
http://www.theatlantic.com/business/archive/2012/04/how-to-get-a-bigger-keynesian-multiplier/256383/
I don’t recall if Dave posted that particular link from Garrett Jones, but the three recommendations for a future stimulus seem very sound: (1) focus on unskilled labor; (2) try to target areas of the country with the worst unemployment; and (3) focus on employment sectors with temporary (aggregate demand?) problems.
Or, we could just create another bubble. Just leap from one bubble to the next and hope we don’t slip until after we’re dead.
“If you’re extremely confident that no matter what happens, the federal government is unlikely to allow the particular industry to fail and come what may will always shovel more money at it, it’s the most secure investment in the world. It’s like found money. That’s how I think that healthcare and banking are being perceived these days.
Fair enough. But of course I come from the world of small corporate, and dare I say, at the risk of being narcissistic (sorry, couldn’t resist) that’s where I believe the jobs and real growth are created. They key is “extremely confident.” We naturally have never considered a financial services deal; out of our wheelhouse and generally a ginormous business. But we have considered many a medical device manufacturer. Very sexy. Can be high growth…….until they are not. To your point, they can have “barriers to entry” which is code for regulatory protection. But this is more the case in medical services. Most investment firms who consider medical industry plays have someone living or contracted as a Washington insider monitoring the regulatory environment because they in fact are not secure investments. As I say, you wake up one day……..and its aw shee-it.
Yeah, I think I did. You might notice that his prescriptions closely follow the points I’ve been making here for some time, e.g. our problems are local and differ by locality, etc. That’s where depending on the federal government breaks down. It would be nice if there were a consensus about dealing with local economic problems in somewhat the same manner we do earthquakes, hurricanes, and tornadoes but we don’t.
One point I think is worth mentioning: how to “focus on unskilled labor” is far from obvious. Many of the unskilled have rejected education, i.e. they’re drop-outs. Another significant subgroup is comprised of illegal immigrants. There’s really no practical way our own unskilled can compete with Chinese or Indian unskilled and there’s no easy way to change them from unskilled to semi-skilled (or skilled!).
And, of course, then there’s the problem of unskilled workers receiving the pay of semi-skilled or even skilled workers, something that happens more frequently than you might think. Garbage collectors in Chicago or flag wavers on the highway, just to name two examples.
Three problems with the paper:
1). Ramey usess standard neo-classical models which totally ignore money, debt and the financial sector. She simplifies the economy into two highly unrealistic sectors and assumes anything else going on is macroeconomically irrelevant.
2). She assumes all actors are inherently rational and can forsee changes in government spending several quarters in advance. Her evidence for this rests on rather shaky correlations.
3). Worst of all: She bases much of her analysis on WWII and Korea because there is not sufficient variability in government spending without them to determine spending effects. Nowhere does she control for A) the effect of rationing on private sector spending or B) labor resource constraints due to government drain on manpower as military enrollment surged. This is the equivalent of losing your keys in a dark alley but looking for them under the street-light down the block.
1) You grossly distort Keynesian theory. Nearly 100% agree with..
” I find that in most cases private spending falls significantly in response to an increase in government spending.”
Increased spending in the middle of a boom or after a standard bubble recession probably result in low multiplier. What we really want to know is what happens after a financial crisis when monetary policy is exhausted and private balance sheets are beat.
2) Not all government spending is equal. I thin some Keynesians might believe this, but most think some spending is better than others. Tax cuts, the other side of govt. spending have a lesser effect. 1/3 of the stimulus was tax cuts.
3) Ben hit the WWII problem. I cannot believe a non-partisan economist would even use those numbers.
4) As I have said before, I think the problem we face now is different than what we faced in 1932. We have record private debt matched with high levels of public debt. We were consistently dropping our debt to GDP ratio until 1980, the era of the conservative president. If we had stayed on track, we could have faced this problem with very low levels of public debt. Large amounts of public spending might have worked. I think it now risk such high level of public debt that the chances of success are low.
While I agree with much of Drew’s general preference for private enterprise, I think we need govt spending in research. Absent govt involvement we do not have the internet, antibiotics or modern agriculture, or else they all come much later. (I once got a chance to read some archived records on the development of penicillin. Government boondoggle sticks in my head as a recurrent theme.)
Steve
It just occurred to me that Ramey made a point I don’t believe she intended: If government spending suppresses private spending, then government can spend all it wants with no inflation!!! Steve Verdon’s greatest fear has come to life!