The multiplier is not prosperity

“I’m doing my part to help the economy!”

I’ve heard many folks make this joke after a big purchase. We snicker. We know they really bought it for the personal benefits they expect to gain. As we’ve been discussing in the comments, they bought it because they valued it more than what they gave up.

The joke implies the multiplier effect — the idea that your purchase stimulates economic activity. You buy a car, which means income for the car maker and workers, they spend that income on suits and shoes, and so on. And, by the time it’s all said and done every dollar of your purchase ‘stimulated’ more than a dollars worth of economic activity, which is measured as GDP.

For some reason, we don’t snicker when economists and politicians make this same claim. We should.

David Henderson, who doesn’t make this claim, does a great job explaining why we should snicker in his aptly titled essay, GDP Fetishism, which I discovered after reading a recent post of his about the ‘multiplier’ of foreign aid.

Also recommended, his latest post about subjective value, which is a topic we’ve touched on here recently in the comments.

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10 thoughts on “The multiplier is not prosperity

  1. I’ve been fascinated lately by the Bonneville Power Administration. Apparently it was started in the late 1930′s with a huge federal subsidy but has since paid back the loan and now pays all its bills by selling electricity to local power companies and is still managing to expand.

    It provides about 40% of the power to the NW region – which because of the low cost that it charges the power companies, makes the power rates in the NW region somewhat lower for rate payers. It puts “money back in the pockets” of regular electricity users.

    Granted, this is an old government investment but it is still administered by the government. Isn’t it “helping the economy”?

    • Hi Wally — First, according the BPA’s website, it still has a chunk of debt outstanding to the US Govt (http://www.bpa.gov/Finance/FinancialInformation/Debt/Pages/default.aspx). Not sure if some of that is leftover from the initial construction, but it is a net debtor to taxpayers at the moment.

      But, let’s assume that US taxpayers have earned a good return on their BPA investment and didn’t just subsidize cheap power for the NW.

      The question isn’t whether the BPA helped the economy relative to ‘not having power’ or ‘not have cheap power’ case, though that is commonly how government actions are justified.

      The question is whether it was worth the opportunity costs? Real resources were consumed to build the BPA. Could they have created more value if they were consumed in some other fashion?

      Another question is whether the NW would have power without the BPA? I think yes.

      Still, I’m not categorical in my thinking that government never does any good. I do believe good ideas and value can come from anywhere. After all, we are all people.

      But, the odds aren’t in favor of government doing that consistently because its it stymies trials and its success/failure feedback loops are weak. Local and state governments, as we discussed in the previous post, have better success/failure feedback loops because they have more competition. Even the BPA has competition, albeit in government sanctioned monopoly market structure.

      • Yeah. I’m a little unclear on how their funding works after digging a bit deeper. According to their 2013 budget:

        “Bonneville finances its approximate $4.5 billion annual cost of operations and investments primarily using power and transmission revenues and borrowing from the U.S. Treasury at rates comparable to borrowings at open market rates for similar issues.”

        Was it worth the opportunity costs? I don’t know. How do we determine that?

        • When someone states that their government loans are at rates similar to open market rates, I ask, then why not fund it in the open market? Why are taxpayers on the hook?

          “Was it worth the opportunity costs? I don’t know. How do we determine that?”

          Great question. There is a simple way. Expose it to a true market test by getting taxpayers off the balance sheet and see what happens.

  2. So why are taxpayers on the hook? There must be some advantage to having a government loan as opposed to an open market loan. In addition it seems like if you DO have a government loan you’re probably subject (at least theoretically) to public scrutiny.

    • “There must be some advantage to having a government loan…”

      I believe there are. What do you think some of those advantages might be, Wally?

      Do you think public scrutiny is as strong a feedback as a third-party private lender who would seek specific collateral against a loan? What happens if the BPA defaults on it’s government loan? Does the government take over the government agency or would it just change the terms of the loan to continue its operation?

      Great discussion!

      • “What do you think some of those advantages might be, Wally?”

        I can’t think of any that can’t be duplicated in a business environment. The government makes the rules surrounding loans and then can vote to change those rules (well full house normally would beat a pair but today is Tuesday so on Tuesdays a pair actually beats a full house) but I suspect many banks are pretty good at coming up with clever ways to bend the rules to produce a similar effect.

        “Do you think public scrutiny is as strong a feedback as a third-party private lender who would seek specific collateral against a loan?”

        Tough to say. I’ve certainly seen both governments and businesses grilled in the press for bad economic policy. The feedback loop for business is supposed to be “the bottom line” – can they pay their overhead and turn a profit. The feedback loop for government (elected ones, anyway) is supposed to be the ballot box.

        What happens if the BPA defaults on it’s government loan? Does the government take over the government agency or would it just change the terms of the loan to continue its operation?

        Ha! I love the idea of a failed government agency being taken over by another government agency. (Love in the sense that it tickles me in my “life is absurd” bone.) Who will watch the watchers? (I think the answer is supposed to be us.)

        • “The government makes the rules surrounding loans…”

          What are those rules based on? Are they based on earning taxpayers/lenders a good rate of return or are they aimed at other purposes, like helping to keep those in the NW from paying market rates for electricity?

          ‘The feedback loop for business is supposed to be “the bottom line” – can they pay their overhead and turn a profit. The feedback loop for government (elected ones, anyway) is supposed to be the ballot box.’

          I agree. I’d add that an important part of the ‘profit’ feedback is selling, usually to willing buyers. This is where the voluntary mutually beneficial trade comes in. Customers buy a company’s product because they value it more than what they gave up. So, the transaction is also profitable for the customer.

          The links I provided to you in a recent comment quotes Thomas Sowell do a good job of explaining why the ballot box feedback loop is not as responsive as the profit feedback loop.

  3. Pingback: Profits and Ballot Boxes | Our Dinner Table

  4. Pingback: Don’t Miss the Chance to Privatize | Our Dinner Table

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