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.

Dear Mr. Colmes,

I appreciate what Alan Colmes wrote in his piece in the Wall Street Journal yesterday, How Democrats Made America Exceptional.

I disagree with it, but I appreciate it for a couple of reasons.

First, I appreciate it when someone supports their position with more than “because I don’t like the other side and you just can’t change my mind, so don’t even try!” It allows me to see if there’s something I’m missing and maybe, possibly have a start of productive conversation.

Second, I appreciate that a younger me may have been swayed by some of what Colmes wrote.

There’s much to debate in what Colmes’ piece. I thought this would be a good place to start:

 It was Democrats who fought to extend unemployment benefits during this difficult time. For every dollar in these benefits, the return is $1.64.

In the sentence previous to this, Colmes wrote about the multiplier effect. I’ll assume his ‘return of $1.64′ is a sloppy way to repeat multiplier effect without using the same words.

Still, $1.64 for a multiplier effect is heady.

If Colmes believe this to be the case, I see why he might support expansion of government policies.

If so, he believes government spending flows through the economy creating more economic activity as the recipient of the dollar spends it at the grocer, the grocer spends it to buy more goods, the supplier uses it to pay his workers, and so on.

I remember learning about the multiplier effect in my Econ 101 course and being impressed with it.

I also remember realizing, sometime later, that the magical government mystery dollar had to come from somewhere to begin with: taxes.

It could either be taxed now, in which case that dollar isn’t so magical. The taxpayer could have spent it and got it flowing, no?

Or, if those pesky taxpayers are just being stubborn and not investing their money when I think they should, the government spending dollar could be borrowed against future taxes. Which seems even less magical and strangely inconsistent coming from the crowd who uses future generations to morally justify many other actions.

Well, some of them say, we expect the economy to be humming again by then and our grandchildren won’t notice that teeny extra debt we passed on to them.

But, I wonder if Colmes knows this. If anyone knows him, please ask him for me. Thanks.

Update: Thanks to the comment from Sonic Charmer that made me realize I wasn’t clear on my point. Believing the multiplier is greater than 1 means ignoring, or greatly discounting, where that dollar came from.

The way I understand it, Keynesian folks believe that it’s okay to borrow a dollar from the future in a slack economy to get give GDP a boost now and repay that dollar when the economy is humming. Even in that scenario, the multiplier effect only applies to the current period. The multiplier over time, now and in the future when the borrowed dollar is paid back, is less than one because you have to account for repaying the debt.

Let’s assume that Keynesian logic is good for a short-term GDP boost. That’s still not sound reasoning for someone like Colmes to support ever expanding government on the mistaken belief that government spending is good for the economy because it forever and always has a multiplier greater than one. It does not. That ignores the day when those dollars will be repaid. That’s where Greece is now.