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.

Government Spending: Y Oh Y?

GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G) and Net Exports (X - M).

Y = C + I + G + (X − M)

This is the basic economic equation that appears in every debate over private and public economic activity. Consumption (and exports) are a proxy for production. One can see the inherent relationship between consumption and production; if a society consumes more than it produces, imports (M) increase, net exports (X) decrease and the GDP drops. Thus consumption, itself, cannot keep a society going. Savings, here, could be seen as a threat if it is removed from the economy and goes under the mattress but is a boon if it goes into investment. But investment itself might fail, produce nothing to consume or export, take that money from consumption and be a negative. So consumption could be a negative, investment could be a negative and the import-export balance could be a negative. For some reason we never look at the government spending in the same light.

The key point is, unlike the other factors, government spending (G) is not a proxy for production. The government might build a school for 600 kids grade 1 through 4. That seems like a good place for money to go. But what if the school has only 30 kids show up, or what if each floor has a their own electron accelerator? That will still show up as a positive contribution towards GDP. If the government builds the school for 1200 kids, the contribution to GDP will be double, even though there will be no more use for it than for the school built for 600. If the government realizes its mistake and tears the school down, that expense is more government spending and more contribution to GDP. So the building and then the destruction of a school are both positive contributors to GDP; that is clearly unreasonable. Had a private school made the same investment it would report losses that would accurately reflect the circumstances. It might even go out of business and become fertilizer for the next economic planting. More, the government takes money in taxes to pay for the useless school that could have gone elsewhere, consumption or investment, that would have also contributes to the GDP and might have had the additional advantage of stimulating further investment.

The unused school will never show up in the equation accurately. Government always takes money that might be used otherwise as a real contributor to the economic community and puts that money in areas that are open-ended, that are never judged economically. Moreover, as government spending always counts towards GDP, it is--by definition--productive regardless of how inefficient or costly. Wars are always "productive" but terribly inefficient and inflationary because the government pays for things that blow up on purpose. It would be like building refrigerators that automatically stopped working in 3 months--or building schools to tear them down.

The TARP program is winding down; it is a temporary economic stimulus and its time is up. However, there is an infrastructure of 17,000 employees and they will not be going away. So the purpose of the bureaucracy has ended but the bureaucracy has not. That expense will be counted as a positive for the GDP. There is no negative for government spending. Ever.

Until we are able to look at government spending clearly, not as an absolute number but as a contributor or a threat to GDP, we will never make progress with our economic problems.

Third World Asset Allocation

An editorial in the WSJ today points out the great crisis facing us in another way: When measured in euros the real US per capita GDP is down 25% since 2000. Germany's is up 4% and is higher than the US per capita GDP. The US, measured in currency other than the dollar, is experiencing a decline in wealth.
25% is a big decline. I watched a TV show the other day following two British women house hunting in Cyprus; they were state employees who were evaluating properties I could never consider. The immortal state financial reservoir aside, how did this happen? How has this slow strangling of the dollar been tolerated? Certainly the economists advising on a national level see and know what is happening.
I think they see and know very well. They have decided--wrongly, I think--that the competitive capitalistic system, with its winners and losers, creates enough social instability--or the threat of same--that various distinctive products and services in the country must be homogenized, regardless of the decline in both lifestyle and quality they know will follow. Growth and development will be left to other countries.
This can be very tricky. Declining GDP allows for less and less internal competition as money leaves the system for better rewards elsewhere. Money is created instead of wealth and the currency falls further. The currency continues to flee the country or goes to hard assets (usually augmented with borrowing.) Finally a sad, subsistence-based culture emerges with its inevitable militarily uniformed elite.
It is easy to give the Olympics to Rio; Chicago is old news.