January 08, 2002
From the desk of Jane Galt:Macro 101 JOSHUA MARSHALL questions
Macro 101
JOSHUA MARSHALL questions Larry Lindsay's economic credentials based upon his appearance on Brit Hume's Special Report. Specifically, he takes him to task for denying that unemployment insurance helps the economy to grow during this exchange (as quoted on Talking Points):
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HUME: I want to ask you about something else Senator Daschle said . . ."We included unemployment and health benefits for laidoff workers in our plan because, as any objective economist will tell you, it's one of the most effective ways to boost demand and pump money into the economy quickly."
Setting aside "objective," can you think of any economist who would make that argument?
LINDSEY: Well, I think the president, as you know, is very much for health benefits and for unemployment, but not necessarily for the reason the senator said. He's there because these people need help, and that's why we...
HUME: Can you talk about the economic theory, if there is one -- do you know of any economic theory under which health care benefits and unemployment benefits are used to stimulate the economy?
LINDSEY: Our view is that paychecks are what the objective should be here and not simply bigger unemployment checks.
HUME: And the reason for that is what?
LINDSEY: Well, paychecks are what grow the economy. People who are unemployed need help and we're all for that. But unemployment checks don't grow the economy; paychecks do.
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Marshall's response:
"Now, Talking Points is no economist, but he had always understood that unemployment checks not only create demand and stimulate the economy (which only stands to reason since you're putting money directly into the hands of people who immediately have to spend it) but that this is the point. Unemployment insurance is intended to be counter-cyclical.
"Exactly when the economy is contracting and people are getting laid off you have a roughly proportional, if lesser, amount of money being injected back into the economy. It's a bit like macro-economic shock absorbers. This isn't 'some economic theory', it's Macro-Economics 101. "
Er, no it's not. That is, it used to be Macro 101, before Kennedy et. al. proved in excruciating detail why Keynsian economics doesn't work.*(long explanation at bottom for those who are interested.) Larry Lindsey was right on this one. Of course, he didn't make himself look good by dancing around with sound bites rather than trying to explain the issue, but if you look at the lengthy explanation I'm about to offer for why it isn't true, you'll see that it would have been impossible for him to explain on an interview show. Since the press corps largely took their one or two economics courses during the reign of Keynsian theory, and on very liberal campuses to boot, it's not surprising that Marshall should think this: the consumer spending theory of economic stimulus appears all the time in the media, used to trumpet everything from increased unemployment benefits to the Gore tax plan.
So why is this wrong? The basic media understanding of how unemployment insurance works is that it puts money into the hands of needy people who spend it immediately instead of rich people or corporations. This was also Gore's favorite argument against tax cuts for the rich. But as Rand Simberg points out, rich people and corporations don't stick all their money in a vault so they can swim around in it. Either they spend it, or they put it into some sort of financial asset (bank, stock, whatever) where it goes to someone else who spends it. Spending money on new shoes for the kids, groceries, or a car stereo creates no more wealth for society than spending on concrete mixers or luxury yachts. (I'm talking GDP, not social justice.)
The idea that government spending could somehow create wealth was based on a concept called the "multiplier effect". This was the idea that when the government spent money on, say, Hoover Dam, that money turned into concrete mixers and executive salaries that rapidly turned into luxury yachts. The luxury yacht and concrete mixer spending was translated into spending on labor and raw materials, which spending turned into shoes and groceries and car stereos, creating a little extra demand as it went -- the multiplier effect. Well, let's think about that. Where does the money the government spends come from? George W. doesn't have a money farm he harvests when the need arises; he has to raise taxes, cut spending, or borrow money -- in short, take the money from somewhere else, where it therefore does not turn into salaries, luxury yachts, etc. Zero sum game. (Unless we sell off assets to the Japanese or another foreign nation, increasing our financial capital at the expense of our real assets. I don't think that this is what Mr. Marshall is advocating.) As a matter of fact, most economists would agree that government spending destroys wealth, because government is inherently less efficient than the free market.
Of course, there is one other source of that money -- the printing press. Which is one of the reasons that Keynsian policies are so inflationary.
In fact, unemployment insurance has some measurable negative effect on the economy, because it makes the labor market more rigid; the higher the benefit, the more it costs employers to hire each new person (because of the taxes), and the longer people tend to stay unemployed, seeking the perfect job instead of something to pay the bills. Think of it this way: some number of those people could be paid to do something that someone, somewhere wants; instead they're being paid to to breathe. But they don't want to work at McDonalds or dig ditches; they want to write a novel. No one wants a novel about refrigerator magnets. Labor input decreases; GDP shrinks. The argument in favor of unemployment is the one Lindsay in fact made: those people need help.
There are only two ways for economies to grow. The first is to increase the inputs: labor, via immigration, birthrate, or involuntary servitude; or capital, via aggressive savings (which temporarily shrinks the economy -- it's one of the problems with Japan) or the aforementioned asset sale to foreign nations. The second is to increase productivity via technology, deregulation or trade. This is, I think, what Larry Lindsay was trying to say, although as you can see from the transcript, he didn't say it very well.
* It doesn't have anything to do with John Kenneth Galbraith's explanation that while Keynes expected governments to run deficits during recessions, he expected them to pay down the deficits during boom years. Deficits are certainly a drag on the economy -- they divert investments from highly valued assets like metal pressing machines to less valued projects like the Trent Lott Memorial Hogback Research Center at the University of Georgia. But they are not the problem with Keynsian economics. The problem is that Keynesian theory is -- ahem, somewhat incomplete -- while Keynsian policy is madly inflationary. Keynes was scrupulously disinterested in the long run effects of his policies; "in the long run, we'll all be dead," he said, and how right he was, except that the long run in Keynsian economics turns out to be roughly eighteen months, which leaves most of us ample time to contemplate his folly. The one model he is still widely credited for -- the famous Liquidity Trap which brought you the Great Depression and Japan's current dire straits -- turns out to be immune to his spend, spend, spend! remedy. FDR enthusiasts will tell you different, of course, but while his spending may or may not have averted a revolution, it certainly didn't end the Great Depression, which didn't give up until WWII radically transformed the world's economy. It has proven similarly ineffective in Japan.
Posted by Jane Galt at January 8, 2002 06:41 PM | TrackBack | Technorati inbound links