(…) Cram the process into a dramatically shortened time frame, and the likelihood that the project will be an example of “wise” government spending diminishes significantly. Expand the scope of the government spending from town planning to national fiscal policy, and the likelihood shrinks even further.
This is not just a matter of government waste, but also a question of whether money spent under such circumstances actually helps the economy grow in a way that best enhances citizens’ well-being. Whenever public money is involved, it is important to ask whether the spending will produce something society needs, or wants, to improve the general economic climate. Money spent on a new road that allows farmers to get their products to market faster and in better condition, for instance, creates more value than money spent building a “bridge to nowhere,” even if both projects create the same number of construction jobs.
To look at it another way: If a person pays his neighbor $100 to dig a hole in his backyard and then fill it up again, and the neighbor hires him to do the same, government statisticians will report that the economy has created two jobs and that the gross domestic product has risen by $200. But it is unlikely that, having wasted all that time digging and filling, either person is better off — economically or otherwise. Each person’s net financial gain is zero, and all anyone has to show for the effort is a patch of fresh dirt in the backyard, which is unlikely to improve anyone’s standard of living.
Private individuals don’t usually spend their money on things they don’t want or need. So when money is kept in the hands of citizens, and transactions take place in the private sector, there is less cause to worry about inefficient spending. The same cannot always be said of government. This means that government spending designed to stimulate the economy must first be subjected to serious cost-benefit analysis, which is hard to do in a big rush. Not all government spending is created equal — and rushed spending is, in many important ways, likely to be less efficient and less useful than spending that is carefully planned.
The administration’s second assumption, meanwhile, is a matter of academic theories about the sizes of the relevant economic multipliers. Textbook Keynesian economics tells us that government-purchases multipliers are larger than tax-cut multipliers. And, as we have seen, the Obama administration’s economic team consulted these standard models in deciding that spending would be significantly more effective than tax cuts.
But a great deal of recent economic evidence calls that conclusion into question. In an ironic twist, one key piece comes from Christina Romer, who is now chair of Obama’s Council of Economic Advisers. About six months before she took the job, Romer teamed up with her husband and fellow Berkeley economist David Romer to write a paper (“The Macroeconomic Effects of Tax Changes”) that sought to measure the influence of tax policy on GDP. Crucial to the Romers’ method was their effort to identify changes in tax policy made during times of relative economic stability, and driven by a desire to influence economic behavior or activity (to encourage growth, say, or reduce a deficit), rather than those changes made in response to a recession or crisis. By studying such “exogenous” tax-policy changes, the Romers could be more confident that they were in fact measuring the effects of taxes and not those of extraneous conditions.
The Romers’ conclusion, which is at odds with most traditional Keynesian analysis, was that the tax multiplier was 3 — in other words, that every dollar spent on tax cuts would boost GDP by $3. This would mean that the tax multiplier is roughly three times larger than Obama’s advisors assumed it was during their policy simulations.
(…) Some excellent work on this topic has come from Valerie Ramey of the University of California, San Diego. Ramey finds a government-spending multiplier of about 1.4 — a figure close to what the Obama administration assumed, but much smaller than the tax multiplier identified by the Romers. Similarly, in recent research, Andrew Mountford (of the University of London) and Harald Uhlig (of the University of Chicago) have used sophisticated statistical techniques that try to capture the complicated relationships among economic variables over time; they conclude that a “deficit-financed tax cut is the best fiscal policy to stimulate the economy.” In particular, they report that tax cuts are about four times as potent as increases in government spending.
Perhaps the most compelling research on this subject is a very recent study by my colleagues Alberto Alesina and Silvia Ardagna at Harvard. They used data from the Organization for Economic Cooperation and Development to identify every major fiscal stimulus adopted by the 30 OECD countries between 1970 and 2007. Alesina and Ardagna then separated those plans that were in fact followed by robust economic growth from those that were not, and compared their characteristics. They found that the stimulus packages that appeared to be successful had cut business and income taxes, while those that evidently did not succeed had increased government spending and transfer payments.
(…) There appears to be a growing body of evidence, then, suggesting that taxes may be a better tool for fiscal stimulus than conventional models have indicated.
. Near the end of their discussion the subject of causality came up, here is the transcript:
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