wsj
online...
Ugly Modeling
Will spending cuts ruin or improve America’s economy?
By Veronique de Rugy
From Reason Magazine
In February, the Goldman Sachs economist Alec Phillips predicted on
ABCNews.com that a Republican proposal in the House of Representatives
to cut $61 billion from the federal budget in fiscal year 2011, would,
if enacted, shave two full percentage points off America’s gross
domestic product in the second and third quarters of this year. A few
days later, The Washington Post described a new study by Mark Zandi,
the chief economist at Moody’s Analytics and an architect of the 2009
stimulus package, a.k.a. the American Recovery and Reinvestment Act.
Zandi’s amazing verdict: The spending cuts would destroy 700,000 jobs
by the end of 2012.
After every newspaper had published the gloomy predictions, Goldman
Sachs issued a “clarification” of Phillips’ analysis. Phillips now says
he was misunderstood by journalists eager to spread a doom-and-gloom
message and predicts the impact of spending cuts probably will be mild
and temporary. Perhaps he was influenced by Federal Reserve Chairman
Ben Bernanke, who testified in March at the Senate Banking and Urban
Affairs Committee that Goldman’s numbers were incorrect.
Yet even this correction implicitly assumes that government spending is
the source of all recovery. The logic, as with Bernanke’s and Zandi’s
analyses, is that government spending cuts reduce overall demand in the
economy, which affects growth and then employment. This argument
ignores the fact that the government has to take its money out of the
economy by raising taxes, borrowing from investors, or printing
dollars. Each of these options can shrink the economy.
All these analysts also systematically ignore the fact that GDP numbers
include government spending. When the federal government pumps
trillions of dollars into the economy, it looks as if GDP is growing.
When government cuts spending—even cuts within the most inefficient
programs—aggregate GDP shrinks.
But that’s misleading. If Washington spends $1 a year on a bureaucrat’s
salary, for example, GDP numbers will register growth of exactly $1,
whether or not the employee has produced any value for that money. By
contrast, if a firm pays an engineer $1, that $1 only shows up in the
GDP if the engineer produces $1 worth of stuff to sell. This
distinction biases GDP numbers—and the policies based on them—toward
ever-increasing government spending.
Furthermore, GDP does not capture changes in personal investment
portfolios or changes in private research and development spending. In
the last two years, corporate cuts in the latter area have been large
but unaccounted for. Also not included in GDP: pension benefits and the
U.S. Flow of Funds Accounts balance-sheet information from the Federal
Reserve Board. That means that when it comes to GDP, states’ grossly
underfunded pensions are off the books, along with the loans and
purchases conducted under TARP.
Another problem with these analyses: Economists of all persuasions have
proven to be really bad at predicting the future, especially when it
comes to jobs. Take the stimulus. Forecasters at the White House and
the Congressional Budget Office (CBO) predicted the stimulus package
would create more than 3 million jobs. And in August 2010, the CBO
estimated that the stimulus had indeed created between 1.4 million and
3.6 million extra jobs, thrilling supporters of economic intervention.
But unemployment stubbornly remained around 10 percent.
What was wrong with the CBO’s numbers? “When the upper limit of your
estimate is almost three times the lower limit, you know it is not a
very precise estimate,” the George Mason University economist Russ
Roberts pointed out in testimony to the House Subcommittee on
Regulatory Affairs, Stimulus Oversight, and Government Spending in
February.
The truth is that there is no way to know the real number of jobs
“created or saved” by the stimulus. For that, the CBO would have had to
collect data on output and employment while holding other factors
constant. But the CBO didn’t do that because that’s different from its
job of “scoring” the possible results of proposed legislation. As the
CBO explained in a November 2009 report, “Isolating the effects would
require knowing what path the economy would have taken in the absence
of the law. Because that path cannot be observed, the new data add only
limited information about [the law’s] impact.” In other words, CBO
number crunchers gave it their best guess before the stimulus and
arrived at their subsequent numbers by applying their original
prediction model. If the model is wrong, so are the numbers.
No one knows what economic output would have been without the stimulus,
and no models can tell us the answer. As Roberts testified, “The
economy is too complex. Too many other variables change at the same
time.”
Also, the Zandi and Phillips models are based on the Keynesian view
that government spending produces recovery. According to that theory,
$1 in government spending produces substantially more than $1 in
growth, a phenomenon known as the “multiplier effect.” The Goldman
Sachs study assumes a multiplier greater than three—i.e., more than $3
in additional GDP for each dollar of government spending. But a review
of the empirical literature reveals that in most cases a dollar in
government spending produces less than a dollar in economic growth. And
these findings often don’t even take into account the impact of paying
for that government dollar via increased taxes.
The Harvard economists Robert Barro and Charles Redlick estimate that
the multiplier for stimulus spending is between 0.4 and 0.7. In another
study, the Stanford economists John Taylor and John Cogan concluded
that the stimulus package couldn’t have had a multiplier much greater
than zero. Even the multipliers used by Christina Romer, the former
chairwoman of the White House Council of Economic Advisers, and Jared
Bernstein, economic adviser to Vice President Joseph Biden, in their
January 2009 paper “The Job Impact of the American Recovery and
Reinvestment Plan,” ranged from 1.05 to 1.55 for the output effect of
government purchases. More recently, the Dartmouth economists James
Feyrer and Bruce Sacerdote, who supported the stimulus, acknowledged
that it didn’t boost the economy nearly as much as the administration
models claimed it would.
The use of these outdated models and unrealistic multipliers explains
why Zandi was wrong about how many jobs the stimulus would create. He
claimed “the country will have 4 million more jobs by the end of 2010”
if the stimulus passed. In truth, by the end of 2010 total payroll jobs
had fallen by 3.3 million, and the unemployment rate had risen from 7.8
percent to 9.4 percent. The administration’s post-facto claim is that
unemployment would have risen even more without the stimulus. To argue
this, they again must pretend that they know what would have happened
in the absence of a stimulus.
Now what? Many economists and many members of the business community
argue that recent policy changes have hampered investment, making a bad
situation worse. The prospect of endless future deficits and
accumulating debt raises the threats of increased taxes and of
government borrowing crowding out capital markets, diverting resources
that could be used more productively. As a result, U.S. companies are
less likely to build new plants, conduct research, and hire people.
We have tried spending a lot of money to jump-start the economy, and it
has failed. Now we need to cut spending and lift the uncertainty
paralyzing economic activity. That approach will not just be more
fiscally responsible. It will also empower individuals and
entrepreneurs. And they are the only ones who can bring on a real
recovery.
Ms. de Rugy (vderugy@gmu.edu), a senior research fellow at the Mercatus
Center at George Mason University, writes a monthly economics column
for reason.
Read it at wsj online
|
