Soft Numbers, Hard Results

"There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.
Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil."
- From an essay by Frédéric Bastiat in 1850, "That Which Is Seen and That Which Is Unseen"



Sometimes we ask for more certainty than is available. Equations, for example.

GDP=C+I+G+E-I.

This equation looks rigid but is not. A change in one factor influences many other factors in the equation so that the outcome is often unpredictable. One component is the "multiplier" effect.

Multipliers, the economists just love them. They, in essence, are the proportional changes that occur in GDP when fiscal policies are changed. For example, federal spending influences GDP; it's in the GDP equation: GDP= Consumption + Investment + Fed Spending + Net Exports. But it is not 1:1. For various tax reasons if one decreases federal spending by 1%, there is more likely to be a decline in GDP by 0.5%. This is a crucial concept now when countries are terrified of their debt and are considering "austerity" by cutting spending. The argument against "austerity" is that it causes a decline in GDP --but also tax revenues--so that the deficit does not improve and the economy is still in distress.

But there are some new problems. These numbers are beginning to be reevaluated. Blanchard and Leigh have studies showing that the multiplier for government spending in Europe might not be 1:0.5 but more like 1:0.9 or even 1:1.7. So cutting a dollar in spending drops the GDP by $1.70. It gets worse; there may be national differences. If you remove the Greek and Spanish economies from consideration the multiplier goes back to the traditional 1:0.5.

Temporal distinctions, national distinctions--this is a mess. But the uncertainty has not created caution, has not suppressed ironclad and vehement differing opinion. And these opinions are trumpeted with certainty from every editorial page.

And there is a lot at stake. Look at the Romer study. The Romers have done studies trying to connect tax policy to GDP. Generally they found that a tax increase of 1% reduces real GDP by 3% over the next 10 quarters. This is relatively constant when corrected for government spending, monetary policy, the relative price of oil, and even whether the President was a Democrat or Republican. These results were published in the American Economic Review in June 2010--while Elizabeth Romer was in the White House on the President's Council of Economic Advisers.

In his 2013 budget, President Obama proposes $103 billion in 2013 tax increases, including $83 billion of higher income taxes on those who make more than $250,000 a year, or about 0.65% of GDP. Using the Romer baseline estimate, that would reduce real GDP by 2 percentage points over the next 10 quarters. Based on the general relationship between economic growth and unemployment, such a fall in output implies a loss of more than 800,000 jobs.

Of course, Mrs. Romer is now gone. But the problem remains. In an economic decline, these politicians want to support those on the lower end of the economic scale. But it appears as if increasing taxes is self-defeating; it appears that taxation causes a decline in GDP and aggravates the already precarious economic condition. Spending can be done with borrowed money but that leads to inflation and inflation hits the poor even worse.

The point is not that Blanchard is right or wrong or that Romer is right or wrong. The point is that all of these economic models have enthusiasts with different conclusions. Like "Good pitching stops good hitting" always has the response "Good hitting stops good pitching"; someone always has different numbers, different evaluations and different translations. Sometimes the studies are the same with different conclusions. Medicine is a good metaphor. People are always able to get differing opinions from physicians, but those physicians have no special access to unique studies; they all come to different conclusions from the same studies. More, there is the problem is that many studies are contradictory and that means some are wrong. And, in politics, honesty and sincerity do not necessarily trump inaccuracy.

These politicians are in some real trouble. Greece has shown that confronting problems directly can be hazardous to one's political health.


Perhaps it is better to just appear to care and to help.