A Fallacy of Composition

Copyright, The New York Times Company

In 2009 the New York Yankees opened their new stadium on the north side of East 161st Street, replacing the historic stadium on the south side of the street. Not surprisingly, 2009 spending by consumers, news organizations and entertainment businesses, among others, on the north side of East 161st Street was a lot more than it had been in years past. It all started from the Yankees’ spending at the new location.

So a spending advocate might assert that this episode is proof that spending by one organization can stimulate spending by others, because the spending by the others on the north side of the street surged at exactly the same time that the Yankees started having their people work there.

Of course, such an analysis is flawed, because it ignores what happened on the other side of the street. Much of what happened north of East 161st Street was just a displacement of activity from the south side, rather than a creation of new activity. Even the construction workers building the stadium may well have been drawn from other tasks.

This pattern is not special to the Yankees’ move. A number of studies have shown that consumer spending associated with a sports team to a large degree displaces spending in other areas and displaces spending on other leisure activities; a family is unlikely to conclude that because there’s a new team in town or a new stadium, it should sharply increase its spending on entertainment.

Yet ignoring the displacement effects is exactly what Paul Krugman and Dean Baker have done in their praise of recent studies that use “cross-state variation in stimulus spending per capita to estimate the employment effects of the stimulus,” studies comparing states that received more stimulus to states that received less.

Spending from the American Recovery and Reinvestment Act (a.k.a., the “stimulus”) could be very much like the stadium spending — a locality that received more stimulus spending merely enjoyed a displacement of activity into its area from localities that received less spending, and that nationally little or no additional spending occurred as a result of the legislation.

If you want to know about the national effects of the stimulus, at least part of the analysis has to look at the nation as a whole. The same is true of the national effects of changes in labor supply. If one group suddenly becomes more willing to work, it is possible that the group solely takes jobs from the rest of the population, with no new jobs being created for the nation as a whole.

That is why, in addition to looking at the experiences of specific groups and specific regions, I have examined the effects of supply and demand on national employment. (Professor Krugman and Dr. Baker assert in so many words that I ignore national employment, though my papers on the subject look very much at national aggregates. For example, see Figure 3 and Figure 6 of this paper and Table 2, Table 3, Figure 2, Figure 3, Figure 4 or Figure 5 of this paper).

I found, for example, that national employment increases during the summer precisely because young people are more willing to work. Not surprisingly, the summer surge of young job seekers does seem to reduce employment of the rest of the population, but the net national effect is still almost a million more jobs in the summer.

For now, it appears that government spending reduces private spending, even while it may benefit specific regions or groups.

Supply of Admissions

Professor Krugman is slowly converging to my view that supply matters even during recessions. I'll explain more tomorrow in a more lengthy blog post, but the basic idea has been in my seasonal supply paper (see the final para).

Kudlow Clip

Where's the Stimulus Hangover?

Copyright, The New York Times Company

Last week’s final report on gross domestic product for 2010 provides a fresh opportunity to evaluate the stimulus law passed two years ago. The data and economic reasoning suggest that the effect of government spending on G.D.P. was minimal at best.

As planned, almost all of the tax cuts and public spending increases from the American Recovery and Reinvestment Act of 2009 are finished. The Obama administration and its supporters promised that the fiscal stimulus law would create or save more than three million jobs by now. Their stated intention was to provide government spending while the economy was weak, then end the extra spending as the economy recovered.

But instead of adding jobs, employment is now about two million below what it was when the law was passed in February 2009.

Some of us think that the fiscal stimulus made a bad situation worse, and that employment would have grown, or fallen less, if the stimulus law had not been passed. The Obama administration contends that, apart from the stimulus law, the economy was in worse shape than anyone expected, and that the law kept the employment drop to two million, rather than a potential drop of more than five million.

While the increase in the stimulus by design coincided with economic weakness, the stimulus decline did not coincide with economic strength. Unemployment rates remained high, and employment, home prices and the Federal funds rate remained low as stimulus spending was winding down (as this profile of stimulus spending shows; note that we are now in the middle of fiscal year 2011).

If Keynesian stimulus advocates are correct, economic growth should have been sharply reduced when stimulus spending slowed.

I use real G.D.P. results from the Bureau of Economic Analysis to measure actual economic growth through the end of 2010. In order to compare the results with the Keynesian theory, I assume a government spending multiplier of 1.5, as the Obama administration did when it projected the impact of the law.

Such a multiplier means that each additional dollar in government spending adds $1.50 to G.D.P., and each dollar subtracted from government spending subtracts $1.50 from G.D.P.

Because we know that the economy would have been weak in the first few quarters of the stimulus regardless of the law, I do not begin the measurement until the fourth quarter of 2009, when the president’s Council of Economic Advisers declared that the stimulus law had successfully started a slow recovery.

If the advisers were right, economic growth should have increased further when government spending grew still faster in the next couple of quarters, and then economic growth should have been less as government spending grew more slowly later in 2010.

I have illustrated the Keynesian-multiplier-1.5 as a red line in the chart below, and the actual results as blue squares. The blue square at the end of the red line is the data for the fourth quarter of 2009. If the multiplier of 1.5 held up, all of the data for the subsequent quarters should have appeared on the red line. (The quarters represented by the squares are not in chronological order.)

Instead, actual G.D.P. growth ended up below the red line and, more important, the quarters with more government spending growth tend to be those with less G.D.P. growth.

Stimulus advocates lament that the stimulus law was too small and was significantly offset by shrinking state and local government spending. But my chart measures total government spending at all levels.

We can see from the chart that real government spending did in fact grow rapidly at times and grow slowly at other times: the actual growth rates range from less than 1 percent per year to more than 7 percent per year.

The red line shows that the range was wide enough to, according to the 1.5 multiplier, make G.D.P. growth rates of almost 9 percent per year (technical note: as drawn, the red line does not have a slope of 1.5 because, in terms of growth rates, the slope is the product of 1.5 and the ratio of government spending to G.D.P.).

A number of Keynesians outside the Obama administration would distinguish government spending on “transfers to individuals” from government spending on goods and services (among other things, government spending on goods and services is automatically counted in G.D.P.; transfers are not).

My chart’s green line shows an alternate Keynesian hypothetical based on a multiplier of 0.75, which might represent a smaller multiplier for transfers.

(Because the Obama administration’s original projection made no distinction between purchases and transfers to individuals – even though it knew that much federal spending would be the latter and some federal grants to state and local governments would allow those governments to make transfers – the 1.5 hypothetical is the appropriate one for evaluating their promises of stimulus results, even it is not appropriate for evaluating other Keynesian theories).

The blue squares showing actual results for our economy do not fit anywhere in the cone formed by the two Keynesian hypotheticals, suggesting that, contrary to the Keynesian promises, the stimulus law did not noticeably increase G.D.P. and might even decrease it.

After all, the stimulus spending penalized success, since its benefits — for example, extending unemployment insurance — were aimed at people and businesses with low incomes, and not at those who were working and/or achieving a certain income level. So it would be no surprise if the result was to keep incomes below what they would have been — as in other cases, a counterproductive result of a well-intentioned program.

Perhaps you think that government spending does its stimulation with a lag, but the Keynesian theories do not fit the lagged data any better. The chart below is the same as the one above except that government spending growth is measured in the quarter prior to the G.D.P. growth.

Again, the data fail to fall in the cone predicted by the 0.75 to 1.5 range of Keynesian multipliers. (Further variations on these charts provide no better results).

Recent G.D.P. growth results are just one way to attempt to measure the amount of stimulus the stimulus act provided. But the longer we go without any vivid empirical demonstration of the stimulus law’s potency, the more we are driven either to reject Keynesian theory or to accept it solely as a matter of faith.

Spending and Value Added over the Seasonal Cycle

I've heard some complaints about my seasonals article: that I should have looked at the impact of Christmas value-added rather than Christmas spending. If the complaints prove anything, they prove that Keynesian theory has not yet progressed beyond a statement of faith to a theory that might actually be tested.

First of all, this complaint is a great example of slippery Keynesian rhetoric. We have been told time and time again that the recession and sluggish recovery are to be blamed on too little consumer spending. We can and should help fix it -- create millions of jobs, they claim, with trillions of dollars of government spending. They even claim that unemployment insurance (UI) -- a transfer that is normally expected to reduce employment -- would, these days, increase employment because UI is spending.

In summary, the Keynesians say that spending really matters during a recession, and that employment, value-added, etc., would be the result of that sorely needed spending.

Now we're told that value-added is supposedly what's missing, not spending. So what happens to consumer spending in December is, all of the sudden, no big deal, because most of the December action is purportedly spending rather than value-added.

You might think that I'm being too harsh with the Keynesians because, after all, they are trying to explain economics to politicians and laymen who might be overwhelmed by a term like "value-added", so the Keynesians say "spending" when they really mean value-added.

But UI is an excellent example for sorting this out, because we all agree that UI is spending, but not value-added (UI actually pays people for not adding value!). So Christmas consumer spending should create as least as many jobs per dollar (probably more, for the incentive reasons I mentioned in my earlier post) than a UI program does.

Second of all, in claiming (without evidence) that the retail sales seasonal is very different from the value-added seasonal, econbrowser probably has the facts wrong. Professor Jeffrey Miron has written a book about the seasonal cycle, and reports that value-added falls sharply from the fourth quarter to the subsequent first quarter -- very much in line with the drop in retail sales. The value-added of Christmas is not all that different from the spending.

Third, I do not doubt that December retail sales are associated with some significant production in November, and October, and maybe even with some significant production in the 3rd quarter. But both of my recent posts on this topic repeatedly reference drops FROM DECEMBER TO JANUARY. At lot of the seasonal jobs lost at the end of the year include those that started in October and November, so in making December-January comparisons I do not have to assume that all of the employment and production associated with December spending occurred in December.

Keynesians are understandably nervous that the seasonal cycle appears to contradict the most fundamental tenets of their theory. Many of them really do think that government spending is as good as Christmas.

The Holiday Stimulus Package

Copyright, The New York Times Company

With Christmas each year comes lessons about the role of demand in the economy.

Retail sales are typically 15 to 20 percent higher in December than they are in September, October and November, and 30 percent higher than they are in the following January (as averages show for 1939 to 2009).

In dollar terms, that means that retail sales rise and fall by roughly $90 billion in a single month.

A $90 billion change in spending in a single month is larger than even the American Recovery and Reinvestment Act, the fiscal-stimulus legislation that was increasing federal government spending by about $50 billion a quarter (less than $20 billion a month).

Likely a consequence of December retail spending, December employment is high each year. Retail employment in December is typically 3.9 percent higher than in October and 5.2 percent higher than in the following January. Some extra retail employment comes at the expense of non-retail employment, but total employment may be as much as 500,000 greater in December than in other months, because of the retail surge.

Although the holiday spending surge is clearly associated with a high level of employment, it also shows how spending is a rather indirect way of creating jobs. That holiday spending of roughly $90 billion more in December is associated with about 500,000 additional jobs for a month – that amounts to $180,000 per job per month!

Both Christmas and the fiscal-stimulus act increase demand, but the fiscal-stimulus act depresses supply, because many of its major programs – the unemployment-insurance extension, the food-stamp program expansion, the home buyer tax credit and more – are directed at people with low incomes.

In other words, the less you work and earn, the larger your entitlement to various components of the act.

By reducing supply as it increases demand, the fiscal-stimulus act could well reduce total employment, rather than increasing it as Christmas does.

In any case, our experience with Christmas shows how large amounts of spending do not necessarily create large numbers of jobs.

Stimulus Interview

About 14 minutes ... for a shorter version, jump ahead to the 6:40 mark.

http://www.bbc.co.uk/worldservice/business/2009/03/000000_business_daily.shtml

Jobs Created or Saved

A translation of White House econ jargon from Jonah Goldberg:

The White House insists that it's ... responsible for every single new job that has been created or "saved" since then. Forget the "saved" part since that has always been so much Bidenesque frippery. (Though for the record, I drink scotch because it keeps away vampires and ensures the moon doesn't catch fire. You can thank me later).

Kudlow Show Oct 1

How Can the Private Sector Grow? Let the Government Shrink

Copyright, The New York Times Company

Stimulus advocates have offered the United States engagement in World War II as evidence that government spending can end a depression and expand an anemic private sector. They are incorrect about World War II and give dangerous advice for today.

The Great Depression began in 1929 and lasted too long. Stimulus advocates tell us that the government spending surge that occurred as a result of our joining the war is the primary reason the Great Depression eventually ended.

The chart below shows the civilian unemployment rate from 1929 through 1941. With the exception of the last 24 days of 1941, the United States was not at war during those years, and its real government purchases were less than a third of what they would be during the war. Yet the unemployment rate had already come down sharply by the end of this period.

It’s true that World War II had an effect on top of the recovery the United States had experienced before Pearl Harbor, but that effect is easily exaggerated. The expanded wartime capacity did not primarily come from putting the Depression unemployed back to work but by drawing into the marketplace women, teenagers and others who were not part of the Depression labor force.

Nor did wartime military spending expand the private sector. Many parts of the private sector shrank during the war precisely because the government was spending so much.

We are at war in Iraq and Afghanistan today, and who knows what might be next? It is incorrect, and deeply unfortunate, for stimulus advocates to suggest that today’s war spending of almost $200 billion a year is doing its part to prop up our nation’s private economy.

If the Iraq or Afghanistan wars ended and, say, 500,000 troops were discharged from duty, our private sector would not contract, as stimulus advocates contend. Rather, the private sector would expand to absorb the new veterans, in much the same way that the private sector expands every summer — even in a recession — to absorb more than a million teenagers who are “discharged” from school at the end of the academic year.

A shrinking government, not a growing one, helps the private sector expand.

A Good Time to Measure

Copyright, The New York Times Company

The tax cuts and public spending increases from the American Recovery and Reinvestment Act of 2009 are coming to an end, and economists and politicians disagree as to whether the federal government’s “stimulus” should continue. But the conclusion of the act offers a unique opportunity to measure the impact of fiscal stimulus.

The Obama administration and its supporters promised that the fiscal stimulus law would create or save more than three million jobs by now. Their stated intention was to have the government spending while the economy was weak, then end the extra spending when the economy was recovering on its own.

But instead of adding jobs since the law was passed in February 2009, our economy has reduced employment by more than two million.

Some of us think that the fiscal stimulus made a bad situation worse, and that employment would have grown, or fallen less, if the stimulus law had not been passed. The Obama administration contends that, apart from the stimulus law, the economy is worse than anyone expected, and that the law kept the drop in unemployment to two million, rather than more than five million.



We probably will never know how much the economy would have grown or shrunk in 2009 and 2010 without the stimulus law and thus cannot disprove the argument that events outside the federal government were destroying jobs faster than the federal government could ramp up its spending.

But the 2010 fiscal year is coming to an end in less than three months, so that almost three-quarters of the law’s spending boosts and tax cuts are behind us. In the 2011 fiscal year, the law’s combined tax cuts and extra spending will be $265 billion less than in the current fiscal year.

Source: Congressional Budget Office

If stimulus advocates are correct that this recession is deeper and longer than they thought, for reasons beyond the federal government’s control, then having the government now tighten its belt by $265 billion will cause employment to fall as much as another million from its currently stimulated levels.

If the stimulus skeptics are correct, then fiscal 2011 will finally be a time when the private economy can grow. We’re only a few employment reports away from resolving this debate.

Flashback: Model of Zero Multiplier

Professor Krugman and Delong are again trying to perpetuate the myth that a multiplier less than one is inconceivable for today's stimulus and today's economy.

In fact, there is a very simple story of how the multiplier would be zero (and, of course, zero is less than one). Namely, in the model, the government buys things that are so useful that citizens would have purchased them on their own. Once the government comes along and buys such things on behalf of its citizens, the private sector stops buying them, and total spending is unchanged both in total amount and in terms of the types of goods purchased.

This is not the only model of fiscal policy that economists use, but it is used a lot, so I am surprised that Professors Krugman and Delong overlook it so often (I wrote about this earlier this year, when Professor Krugman also seemed to forget).

So it's clear that we have models with multiplier less than one. Moreover, the Obama administration claims that its stimulus really did purchase things that are useful. So the possibility that the multiplier is less than one cannot be dismissed solely on the basis of logic.

Which Matters: A Program's Name or Its Actual Consequences?

Milton Friedman poses the question in this video posted here.

The "Stimulus" Law of 2009 is a huge example of a public program with consequences opposite of its name.

"Stimulus Law" Reduces Supply: Food Stamp Edition

Another part of the "Stimulus" law spends $21 billion increasing food stamp spending.

It is well known that the food stamp program acts as an implicit tax on earning, because fewer food stamp benefits are awarded to people who earn more.

This paper (Appendices B & C) calculates some marginal tax rates as a function of income, which I have translated into economy-wide average marginal tax rates from food stamps for the program BEFORE the stimulus law (the average includes zero marginal tax rates for the large number of people not eligible):

person-weighted average marginal tax rate (pre-stimulus): 4.1%
income-weighted average marginal tax rate (pre-stimulus): 1.1%

The stimulus increased the food stamp budget by 13 percent, so impact of the stimulus was to increase marginal tax rates from the food stamp program by:

0.5 percentage points (person-weighted)
0.1 percentage points (income-weighted)

The impact may seem small, but this is just a sliver of the stimulus law. If the rest of the stimulus ($766 billion in addition to the $21 billion on food stamps) were offering the same kind of incentives, the overall impact on marginal tax rates would be:

19.9 percentage points (person-weighted)
5.6 percentage points (income-weighted)

In case you think that adding 20 percentage points to marginal tax rate would not reduce employment during a recession, take a look here.

Does "Making Work Pay" Actually Make Work Pay, or Raise GDP?

The "Stimulus" law's single most expensive provision was "Making Work Pay". It is a $400 tax credit to persons with ANNUAL earnings in between $6452 and $75000, and lesser amounts for persons earning outside the range (reaching zero at $0 and $95000).

So this provision does encourage people to earn somewhere in between $6452 and $75000, rather than earning outside the range. In order to understand how that relates to "making work pay", we need to know whether it does more to pull incomes down into that range from above, as opposed to pushing them up from below.

THE NATIONAL EMPLOYMENT RATE
One question is how many people earn zero for the year, but are on the margin for working. This is difficult to know exactly but, for example, the 2009 CPS demographic supplement says that 10 percent of men aged 25-54 in 2008 earned zero that year. Only 3 percent of men and women aged 25-54 in the labor force (but not necessarily working) in March 2009 had zero earnings for 2008. So let's say that the number of persons who might consider changing their annual earnings from zero to a positive amount is equal to 5 percent of the labor force, or about 7.8 million people.

Another 20.5 million people had earnings between 0 and $6452 for calendar 2008. So we have a total of about 28 million people encourage to work, or work more.

8.4 million people earned between $75K and $95K in calendar 2008.

So clearly there are more people induced to earn more rather than less, and we can conclude that "making work pay" did push in the direction of raising the national employment rate (how much is a much more complicated question).

GDP
Note that the types of people encouraged to work more are different than the types of people encourage to work less, so it is possible that "making work pay" could reduce GDP even while it raises national employment.

The 8.4 million people earning $75K and $95K in calendar 2008 had an average income of $83K, as compared to $3K for those 20 million earning $1-6452 (who knows what the 7.8 million who earned zero would have earned if they had worked). Obviously, $400 seems like more to the latter group, and therefore would tend to motivate a greater change in hours or weeks worked for them: a rough adjustment for this compares the marginal tax rates for the two groups. The former group's marginal tax rate was 2% (ie, they lost $20 of tax credit for every $1000 they earned), and the latter group's was -6.2% (they gained 62 dollars of credit for every $1000 they earned).

So the income-weighted average marginal tax rate for the two groups was (8.4*83*.02 - 28*3*.062)/(8.4*83+28*3)= +1.1 percent. In other words, on net Making Work Pay probably REDUCED the supply of income, because its income-weighted average marginal tax rate was positive, rather than negative.

SUMMARY
In summary, a good guess says that "Making Work Pay" may have increased national employment and hours, but it is highly unlikely that it increased GDP. The Treasury cost of the program was not only the $116 billion budgeted, but also the loss of other tax revenues due to the net disincentive to earn.

Professor Glaeser Confirms that the "Stimulus" was Poorly Targeted

The law gives the most per capita to states with the least unemployment. Read more here.

-----
added: The White House appears to read economix, and yesterday offered a rebuttal of Professor Glaeser's critique.

As you know, I write weekly at economix, so we can understand the White House's complete silence regarding my critiques to mean that they do not have much to say:

• Stimulus Plans Might Do Good, but Not Actually Stimulate
• An Ill-Timed and Ill-Targeted Stimulus
• Forget a Second Stimulus. Stop the First One!
• Does Aid to States Stimulate the Economy, or Votes?
• What Weve Learned: Incentives Matter, Even to the Irrational
  

Obviously, they agree with "Who's Afraid of the Big Bad Deficit?" and "More Government Debt, Please."

In case you are wondering where else the CBO went wrong, look here. In short, they completely ignore incentives even while a long economics literature has shown that they have real effects, even in recessions.

CBO Ignores Incentives

The CBO has a report on the effects of the "stimulus" law. To its credit, it does attempt to address some of those who say that the "stimulus" law did not stimulate (see its appendix).

However, it does not address the single biggest criticism I have made on this blog, on TV, and elsewhere: that much of the stimulus spending (and many of the so-called tax cuts) goes only to persons and businesses in financial hardship, and thereby serves as a tax on success. In other words, stimulus spending is an implicit income tax, and thereby reduces national income rather than increasing it.

Implicit taxes have been familiar to economists for decades, and are widely acknowledged to be a big part of the economics of pensions, unemployment insurance, welfare, and other programs: the CBO and so many other economists have no excuse for ignoring them.

The CBO claims to be critical of general equilibrium models (although it approvingly cites a bunch New Keynesian general equilibrium models), but the problem with implicit taxes has nothing to do with general equilibrium reasoning.

The CBO also offers some critiques of "rational models", although the problem with implicit taxes has nothing to do with rationality, either.

Why is Employment Falling? How to Turn it Around?

Debated on The Kudlow Report tonight:

Welcome Kudlow Viewers!

Below are my posts on the fiscal stimulus. See also my list of reasons why government policy has been reducing employment, not raising it.

To see my posts on other economics subjects, please click on "all posts" above.

I also blog weekly at the New York Times www (one of my favorites is here).

White House Admits Overstating Stimulus Jobs

http://apnews.myway.com/article/20091029/D9BKMVMG0.html

Just a "mistake." Am still waiting for mistakes that underestimate the potentcy of the stimulus.