Wednesday, October 26, 2011

Worst economic argument, ever!

In an opinion piece published in the New York Times, Rutgers history professor James Livingston argues that the cornerstones of economic growth are consumer spending and government spending. And, according to Livingston, private investment monies are not even needed to grow the economy.

To support this controversial claim, he looks at some numbers: GDP per capita and business investment as a share of GDP. In his words:
Between 1900 and 2000, real gross domestic product per capita (the output of goods and services per person) grew more than 600 percent. Meanwhile, net business investment declined 70 percent as a share of G.D.P. What’s more, in 1900 almost all investment came from the private sector — from companies, not from government — whereas in 2000, most investment was either from government spending (out of tax revenues) or “residential investment,” which means consumer spending on housing, rather than business expenditure on plants, equipment and labor. 
In other words, over the course of the last century, net business investment atrophied while G.D.P. per capita increased spectacularly. And the source of that growth? Increased consumer spending, coupled with and amplified by government outlays.
Far be it from me to rain all over someone's parade, but there seems to be a little problem here. To whit: the variables are not independent ones. Comparing GDP per capita to investment levels as a function of GDP to make this case is, well, stupid.

Economic growth is most effectively measured in terms of GDP per capita, this is true. But it's a major error to suppose investment as a share of GDP is a useful metric to assess the consequences of investment on GDP, itself. Private investment has a ripple effect throughout the economy. Government investments do too, actually. And we might remember that the current admin was counting on this effect--from stimulus monies--to drive growth. But as Veronique de Rugy at Reason Magazine notes, this was a pipe dream, based on actual evidence:
So what do the data say? There aren’t many studies of the issue. But two stand out: Robert Barro’s work and research by Valerie Ramey, an economist at the University of California–San Diego, on how military spending influences GDP. Both studies found that government spending crowds out the private sector, at least a little. And both found multipliers close to one: Barro’s estimate is 0.8, while Ramey’s estimate is 1.2. This means that every dollar of government spending produces either less than a dollar of economic growth or just a little over a dollar. That’s quite different from the administration’s favored multiplier of four. What’s more, Ramey also found evidence that consumer and business spending actually decline after an increase in government purchases.
Note the last bit: government spending also drives down consumer spending. So Livingston's two cornerstones can't even work in concert.

The long and short of it is that in a fully developed economy, private investment monies drive economic growth, and that includes consumer spending. Thus, continual private investments will lead to an increasing GDP and an increasing amount of consumer spending, which will then also lead to a greater GDP. And the reason why private investments are more effective than government spending in this reagrd is simple: Smith's old "invisible hand," the market can make better use of the money than the government.

Livingston makes the mistake of a first-year statistics student: he mistakes correlation for causality. Not only that, he does it in big, bold letters in the New York Times. Funny, but also very sad.

Cheers, all.

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