Testimony on Work Incentives, the Recovery Act, and the Economy

Overview (about 5.5 minutes)
Do Transfers Stimulate the Economy? (about 2.5 minutes) Politically Incorrect (about 3 minutes) Will the ACA affect employment? (about 2 minutes) Unemployment isn't fun (about 1 minute) What are the effects of payroll subsidies? (less than one minute) Written testimony here.

Research-free Policy Analysis

A widely held belief: "[The poor and unemployed] will spend a large fraction of any aid, and therefore transfers to that group will have a much bigger multiplier effect than, say, tax cuts for the rich." The exact words are from Professor Krugman, but many others believe it.

Where is the research that supports the claim that transfers to the poor and unemployed have a multiplier effect on GDP?

Where is the research that supports the claim that transfers to the poor and unemployed have a multiplier effect on aggregate employment?

Empirical research would be best. A theory would be interesting too, as long as the theory were complete in terms of recognizing that the funds have to come from somewhere.

Commenters please let me know. To get you warmed up, let me note some irrelevant replies:

• Irrelevant Reply #1. Theoretical research by Woodford, Rebelo, Werning, Krugman, Eggertsson, and others on what they call the "government spending multiplier". Those authors really mean government purchases, which are quite different from the transfers I'm asking about. If nothing else, GDP by definition includes government purchases but does not include transfers.
• Irrelevant Reply #2. Empirical estimates of the "government spending" multiplier. As far as I know those studies measure government purchases (esp Department of Defense purchases), not transfers, and purchases are quite different from the transfers I'm asking about.
• Irrelevant Reply #3. Empirical estimates of the consumption behavior of the unemployed (this one is a classic). I am not asking whether the poor and unemployed spending their money differently than everyone else does -- they do. I am not asking whether aid to the poor and unemployed expands the markets for the things the poor and unemployed tend to buy. I am asking about the effects on aggregate GDP and employment, including all of the sectors -- even the sectors that do not disproportionately serve the poor and unemployed.

Interesting Reply. This new Keynesian model addresses the question I am asking. Not surprisingly, it finds that the "Keynesian aggregate demand effect" is trivial. The model also features a wealth effect of transfers by assuming, without explanation, that the poor and unemployed's labor supply is less sensitive to transfers than everyone else's labor supply.

Welfare Arithmetic Event Tomorrow

***EVENT TOMORROW***   American Action Forum Event Will Examine Stimulus Spending Effects on Welfare Efficacy   Speakers Include Jared Bernstein, Center on Budget and Policy Priorities; Casey Mulligan, University of Chicago; Shannon Mok, Congressional Budget Office   WASHINGTON - The American Action Forum (@AAF) will host an event tomorrow, Wednesday, January 23 examining the link between stimulus spending and welfare efficacy. University of Chicago Professor Casey Mulligan will first present findings from his recent paper, “The ARRA: Some Unpleasant Welfare Arithmetic.”  Following the presentation, AAF’s Director of Fiscal Policy, Gordon Gray, will moderate a discussion on the paper’s implications between Jared Bernstein of the Center on Budget and Policy Priorities and key contributor to the design of The ARRA and Shannon Mok of the Congressional Budget Office and lead author of a recent CBO report on effective marginal tax rates on low and middle income workers. RSVP here. Watch live online here.   WHEN: Wednesday, January 23th from 9:00AM – 10:30AM   WHAT: Getting Employment Incentives Right: ARRA and Marginal Effective Tax Rates   WHERE:   National Press Club, Holeman Lounge 529 14th Street Northwest Washington, DC 20045 RSVP: http://arra.eventbrite.com/# LIVE STREAM: http://www.visualwebcaster.com/event.asp?id=91799   AGENDA   8:30 AM: Doors open, breakfast will be served   9:00 AM Presentation: “The ARRA: Some Unpleasant Welfare Arithmetic”   Casey Mulligan, University of Chicago   Discussants:   Jared Bernstein, Center on Budget and Policy Priorities Shannon Mok, Congressional Budget Office   Panel discussion will include time for audience questions.   Moderator:   Gordon Gray, American Action Forum   10:30 AM Conclusion For press inquiries, contact Noelle Clemente at nclemete@americanactionforum.org or 240-888-7310.

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Recession by Redistribution

Copyright, The New York Post

Doubt of the benefit

Why increasing unemployment aid is prolonging the recession

By CASEY B. MULLIGAN

More families used food stamps this past Thanksgiving than ever in history, while Congress is pushing to extend benefits — again — for the longterm unemployed.

But what if such aid isn’t helping us weather the recession, but instead prolonging it?

The White House, and other believers in Keynesian policy refer to subsidies to the unemployed, poor and financially distressed as “automatic stabilizers” and insist that subsidies have a large positive effect on national income.

Yet when the subsidy spigots were opened wide in 2008 and 2009, labor market activity contracted sharply, and stubbornly refuses to rebound.

Getty Images

It is time to reconsider the old-school economic idea that paying people to be unemployed reduces employment. The more we pay poor people, the more poor people we will have. The more we help people and institutions in financial distress, the more financial distress there will be.

It is easy to look at a particular instance of redistribution — say, unemployment benefits — and conclude that its aggregate effects are minimal, or approximately zero. But policymakers did not expand just one provision of one program.

Food-stamp recipients were given a big raise in October 2008, and then another raise six months later. Thanks to the elimination of asset-testing by the majority of states, just about anyone who is the sole earner in their household now find themselves eligible for food stamps during periods of unemployment.

The American Recovery and Reinvestment Act, popularly known as the stimulus, gave unemployment insurance recipients a weekly bonus, and offered to pay for the majority of their health insurance expenses. FDIC and Treasury reduced some “unaffordable” mortgage payments, which means that successful people need not apply. The list goes on and on.

The essential consequence for all of these is the same: a reduction in the reward to activities and efforts that raise incomes.

I’ve studied how redistribution affects the “reward” for working.

We start with a monthly index of government benefits. Before the recession began, an unemployed person typically received about $10,000 a year in government benefits. By the end of 2009, program rule changes alone had increased the typical benefit to almost $16,000.

Plot that against the hours an average American adult spends away from work in a year (the difference between total hours in a year and hours at work). Largely because of the increase in the number of people without jobs, the average work hours were about 120 fewer at the end of 2009 than they were at the end of 2007 — a 10% decline.

But things start to change at the beginning of 2010. Slowly, the number of hours of work by the average American begins to climb. Not coincidentally, the average annual government benefit for the unemployed dropped to $14,000.

The increase in benefits provides a disincentive to work. From 2007 until 2009, I found a startling 13% decline in the “reward” for working — that is, how much better the average job would be over collecting benefits.

Considering that, why is the labor market still so far from a full recovery? Because government benefits are still far from returning to pre-recession levels.

But wait, a Keynesian would say. Unemployment benefits are good for the economy overall, since it is money spent and not saved.

It’s true that the poor and unemployed tend to quickly spend what they have on basic needs. Yet Keynesians have gone further to claim that spending patterns of the poor are why redistribution raises total spending and thereby employment. Redistribution changes the composition of spending and employment in the direction of industries like discount groceries and low-cost retail that disproportionately serve poor customers and away from industries like, say, airlines. The stimulating effects of benefit spending for the overall economy is limited.

Redistribution is not free. Redistribution depresses employment, aggregate spending and GDP, by implicitly punishing the successful and implicitly rewarding the unsuccessful.

We don’t like to see people suffer, and it’s a natural instinct to want to increase redistribution in a time of recession. But the better economic solution reduces the implicit penalties of government aid, and gets more people working, so they don’t need the help.

Casey B. Mulligan is a professor of economics at the University of Chicago and author of the new book “The Redistribution Recession” (Oxford University Press); redistributionrecession.com

We are Supposed to Trust Them with Trillions

DeepenEnd This Depression Now! insists that we taxpayers should trust the author and other Keynesians with trillions of our dollars, and in return they supposedly would end this depression fully and quickly. Meanwhile, the best the author can do to earn our trust is to take a vacation from both logic and economic understanding:

1. He and I agree that soup kitchens did not cause the Great Depression.  But only he can conclude from that fact that incentives should be ignored when studying the labor market, and that the best way out of this recession is to further broaden the population of people with no incentive to work.
   
   
2. He and I agree that a massive safety net expansion all by itself would increase wages (he never says by how much, though ... my book looks extensively at that: it's just a couple of percent in the short run, and then falling back to trend).  Then, with the intention of showing that safety net expansions were trivial, he puts up a graph showing that wages continued to increase (sic) after the recession began!  Notice in particular the vertical axis in his chart (and ignore that he cherry-picks a disportionately manufacturing sample ... my book shows how manufacturing did experience a sharp demand reduction but that manufacturing is not the entire economy): the axis is measuring wage CHANGES and all of its numbers are positive.
   
   
3. If he had wanted to test the theory a little more carefully, he might have looked at wage levels, and acknowledge safety net contractions as well as expansions.  That's what I did in my book, and in my "Why did wages rise and then fall?"  Here's what you get: real wages rose above trend when the safety net expanded, and did not start to fall until part of the "stimulus" started to expire.

4. We can quibble about whether wages went up a couple of percentage points or went down a percentage point or two, but the real issue with wages is what happened to after-tax wages: they fell about 12 percent below trend because of the massive hikes in marginal tax rates. So even if you really did have a demand drop that by itself depressed pre- and after-tax wages by 3 percent, and a safety net expansion that by itself increased pre-tax wages by 2 percent and depressed after-tax wages by 9 percent, then the net result would be pre-tax wages falling by one percent -- Professor Krugman and friends could have their "gotcha" -- yet still after-tax wages fall by 12 percent, three-quarters of which is due to the safety net expansion. If your choice was to ignore the safety net and focus on demand or ignore demand and focus on the safety net, you would get a lot closer to the truth with the latter approach.
   
5. when it comes to real wages, my model is Keynesian in the sense that it says that wages are counter cyclical (high when employment is low). It's kind of funny that, regardless of what the data show, Krugman would attempt to discredit the Keynesian part of my model by insisting that wages are procyclical. I guess he sides with Kydland and Prescott on wages and indeed he does appreciate nonKeynesian approaches :)
   
   
   

Summary and Highlights of End This Depression Now!

Despite the fact that DeepenEnd This Depression Now! arrives at exactly the backwards conclusion, it has a number of highlights and interesting observations. First an editorial-free summary:

Chapter 1: There are lots of unemployed people and they are suffering.  Unemployed people are hurting and are not happy.

Chapter 2: Because the structural theory is wrong, insufficient demand is the only explanation for what has happened.

Chapters 4 and 5: Because the mortgage mess was not exclusive to low-income borrowers, the mortgage crisis was primarily inequality gone wild.  Government was not an independent force, except perhaps in lending a bit too much to low-income borrowers.

Chapter 6: All about economists, nothing about the economy

Chapter 7: The stimulus should have been bigger.

Chapter 8: The deficit is over-rated.

Chapter 9: He was right about inflation.

Chapter 10: About the euro and why European countries should have remained more independent

Chapter 11: “Austerity” has depressed economies, not expanded them.

Chapter 12: Spend like crazy, and the economy will fully and quickly rebound.

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[editorial starts here]

Chapter 10 could stand by itself as a very nice mini book.  One quibble: it could benefit by discussing what happens to unemployment benefits, from a household point of view, during a currency devaluation.

Chapters 4 and 5 arrive at many incorrect conclusions, but I totally agree that social scientists interested in just about any social change in the last thirty years have to look at growing inequality as one of the potentially key driving forces.  That's the point of my 2008 QJE paper (with Yona Rubinstein) about how growing inequality may be the single biggest factor transforming the women's labor market (transforming for the better, from the "progressive" point of view).  That's also the point of Chapter 10 of The Redistribution Recession.  Growing inequality has produced some "bad" results too, and it's worth looking over Krugman's list.

I agree that the government budget deficit gets way too much attention, and thereby distracts from the real issue (incentives faced by individuals and businesses).  But after that basic insight, Chapters 7 and 8 are confused, and misleading.  They engage in the usual trick of conceptual flip-flopping between government purchases and government transfers to individuals, without ever noting the distinction and how different the economic effects of these are.

Those chapters claim that Democrats did not expand government spending, the recession did.  When scoring the effect of Democrats on government spending, Krugman says, you have to exclude the "income security" components.  But Chapter 3 of The Redistribution Recession shows how safety net program spending grew primarily through legislation changes -- usually Democrats (esp. Obama and Pelosi) putting their signatures on new laws.  Income security spending would have grown much less if the laws had been constant and the programs merely reacted to the growing number of unemployed.  Krugman might say that the recession necessitated law changes, but then his claim becomes tautological: government expansion that Krugman deems as needed is not government expansion.

In a book dedicated by an economist to the unemployed, it is funny to find Chapter 6.  Krugman is no expert on psychology, or the personal lives of economists.  Even if he were, telling the truth about the economY creates enough enemies -- how does it help the unemployed to add to the enemy list with stereotypes of and personal attacks on economISTS?  I could speculate, but I'm no psychology expert either ....

Krugman takes credit, largely deserved, in Chapter 9 for being basically right about inflation in the short and medium term.  Does that qualify him as an expert on the labor market?  What about as a predictor of the next Superbowl's winner?  I doubt it.

The term “austerity” is too imprecise for my taste -- I'd like to see at least something about marginal tax rates and the distinction between purchases and transfers -- but I basically agree (see Q6 here) with Chapter 10's conclusion that austerity has failed to expand the economy. 

Here are a couple of other memorable quotes from the book that are inspiring for Keynesians and non-Keynesians alike:

Chapter 5/page 85: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”  (quoting Upton Sinclair)

Chapter 6/page 94: “there are valuable human activities which require the motive of moneymaking and the environment of private wealth-ownership for their full fruition” (quoting Keynes)

Chapter 8/page 146: “it follows that the level of debt matters only if the distribution of net worth matters, if highly indebted players face different constraints from players with low debt.”

Are Keynes and Sectoral Shifts Mutually Exclusive?

Copyright, The New York Times Company

The decline of home construction is not the primary reason that our labor market remains depressed: Keynesian policies are.

If we accept that the housing sector was overbuilt by 2006, then it might seem inevitable that a recession would follow as the housing sector downsized, workers shifted from construction to other industries and workers moved from overbuilt regions to other places in America.

But as Paul Krugman points out in his “End This Depression Now!” the recession of 2008-9 did not have many industries that were growing, let alone growing as a consequence of reallocation away from home construction.

Moreover, transitions between industries and regions have happened before, but happened gradually as demographic and other trends slowly but powerfully altered the composition of economic activity. By comparison, this recession came on suddenly.

To put it another way: for every worker that construction lost between 2007 and 2010, the rest of the economy lost at least another five workers, rather than gaining workers. I agree with Professor Krugman and other opponents of the “sectoral shifts theory” that something must have happened — in less than a year or two — that profoundly affected practically all industries and practically every region.

But just because sectoral shifts are at best a small part of what happened does not mean that huge government subsidies would take the labor market back to what it was before the recession. A Keynesian-style demand collapse is not the only aggregate event that could happen or did happen.

In my new book, I explain how, in the matter of a few quarters of 2008 and 2009, new federal and state laws greatly enhanced the help given to the poor and unemployed — from expansion of food-stamp eligibility to enlargement of food-stamp benefits to payment of unemployment bonuses — sharply eroding (and, in some cases, fully eliminating) the incentives for workers to seek and retain jobs, and for employers to create jobs or avoid layoffs.

Economists normally think that eroding incentives (as they call it, raising marginal labor income tax rates) depresses the labor market rather than expanding it, and that it would be tough for the labor market to get back to its 2007 form without returning incentives to what they were back then.

Yet Professor Krugman asserts that he would end this depression now with an even bigger stimulus — with more help for the poor and unemployed — that would further erode incentives and further penalize success.

Remarkably, “End This Depression Now!” says nothing about marginal tax rates or incentives to work, either as they actually evolved or as they would appear in Professor Krugman’s ideal stimulus. Nor does the book explain why economists or anyone else should ignore sharp marginal tax-rate increases, or why paying people for not working would have nearly the expansionary effect of military buildups and the like. (These absences are conspicuous to economists who are familiar with Professor Krugman’s academic work on how excessive debts harm debtor incentives.)

“DeepenEnd This Depression Now!” is full of interesting and relevant observations, but don’t expect its author to mention, let alone appreciate, a non-Keynesian explanation for any of them.

Romer's Case is Fundamentally Flawed

Copyright, The New York Times Company

A fundamental flaw in much of the advocacy for government spending to “jump-start the economy” has been a failure to adequately distinguish government transfers to individuals from government spending on goods and services.

When the Obama administration designed the American Reinvestment and Recovery Act in early 2009, its chief economic adviser and one of the act’s enthusiastic advocates was Prof. Christina Romer of the University of California, Berkeley. Ever since, Professor Romer has insisted that opposition to the act’s purported stimulus value is largely motivated by ideology, contrary to empirical evidence, and is getting in the way of the even bigger stimulus that is needed.

The recovery act had three basic components: government purchases, transfers to the poor and unemployed, and so-called tax cuts. (Parts of the act gave resources to state and local governments, which they could devote to the same three components.)

I agree with Professor Romer that plenty of historical episodes featured surges in government purchases of goods and services, especially but not exclusively purchases by the Defense Department. Moreover, I agree with her that historical episodes can be informative about the modern-day effects of government purchases.

The fatal flaw in Professor Romer’s evaluation of recovery act’s effects occurs when she assumes that transfers to the poor and unemployed have the same employment and output effects as government spending on goods and services.

Economic theory and common sense tell us that paying someone to build a tank or pave a highway – as government purchases often do – has a very different effect than paying them for not working or paying them for earning less rather than more – as the law’s transfers did.

Professor Romer calls herself “an empirical economist” and might therefore eschew economic theory and common sense until it is supported by empirical evidence. But she fails to mention that dozens, if not hundreds, of empirical studies have found that safety-net programs discourage people from working and discourage employers from hiring (there are so many studies that there are now studies of studies, summaries of meta-analyses and so on).

That literature offers a range of estimates, and sometimes passionate arguments among its authors, but certainly does not support the idea that incentives are negligible, especially when the government obtains the large majority of the proceeds of a person’s work.

Understandably the law was put together hastily in early 2009 as people feared that the recession was getting out of control, and some bases were momentarily left uncovered. But almost four years later, an empirical economist should have noticed that the legislation eroded incentives to work and eroded incentives for employers to hire or avoid layoffs, and that these parts of the act by themselves are likely to have reduced employment and certainly did not expand it as much as government purchases would.

An empirical economist would also notice that the demographic groups whose work incentives were eroded the most by the law, like unmarried people, were remarkably the same groups whose employment and work hours fell the most. By further expanding safety-net programs, a bigger stimulus would only have created more groups with labor-market outcomes like the unmarried and enlarged the ranks of people for whom government help permitted them to spend more by working less.

Professor Romer might point to a study the President’s Council of Economic Advisers released shortly after she left in 2010, contending that extending the duration of unemployment insurance increased national employment. But that study suffers from the same flaw, because its estimates are based on the backward assumption that the historical “multipliers” for government purchases apply to transfer-program spending too.

In my new book, I explain how the American Reinvestment and Recovery Act did not erode work incentives by extending unemployment benefits (those extensions, examined in the White House study, were put in place by other legislation), but rather by giving unemployed people bonuses, paying for most of an unemployed person’s health insurance and expanding the food stamp program, to name just a few provisions.

Throughout the time Professor Romer has been trying to convince us that the law expanded our economy, she has failed to mention that it eroded work incentives, and she has not explained how its transfers could possibly have the expansionary effects of historical military buildups and the like.

One might expect that the tax credits part of the law would have enhanced incentives and thereby help offset the incentives that were eroded by its transfers. However, many of the tax credits were withheld from people from high incomes. Regardless of whether redistribution is achieved by collecting more taxes from families with high incomes, providing more subsidies to families with low incomes, or both, an essential consequence is the same: a reduction in the reward to activities and efforts that raise incomes.

Studies suggest that the American Reinvestment and Recovery Act helped keep living standards out of poverty, a great benefit that may be worth depressing the labor market. But empirical evidence, economic theory and common sense all contradict Professor Romer’s assumption that transfers to the poor and the unemployed raise employment about as much as the same amount of government spending on goods and services.

The iPhone5 and Consumer Spending

Copyright, The New York Times Company

That the introduction of iPhone 5 increases consumer spending is no triumph for Keynesian economics, but merely an advertisement for plans by the Bureau of Economic Analysis to improve national accounting.

Suppose there were an island economy with 100 able-bodied adults, all of whom work as fisherman, each catching a fish a day. The 100 fish are eaten by the island people, which makes inflation-adjusted daily consumer spending in the economy – or consumption, as economists call it – equal to 100.

(In order to clarify concepts and measurement practices, I have deliberately kept this model economy simple, with no unemployment, liquidity traps and the like.)

Now suppose that 10 of the fisherman decide to quit fishing to build, nurture and tend to an apple orchard. In the beginning, the orchard produces no apples, so consumer spending drops to 90 fish a day, because only 90 adults are out fishing while the other 10 are developing an orchard.

Time passes, and a bountiful 100-apple harvest occurs. Because the apples taste good, the island fishermen obtain all 100 apples from 10 orchard owners in exchange for fish. The apple harvest has by itself boosted consumption in the economy, which suddenly jumped from 90 fish a day to 90 fish a day plus 100 apples.

It would be ridiculous to proclaim that the apple harvest and its effect on consumer spending prove that the economy is plagued by a liquidity trap, or to insist that the immediate effect of the harvest on consumer spending is independent of the quality of the apples. By construction, this model economy has no Keynesian features, yet nonetheless a harvest has a large effect on measured consumption.

Consider now the American economy, in which Apple has just released its iPhone 5, and some economists say they believe that the release itself will noticeably increase aggregate consumer spending. Paul Krugman has gone even further, to assert that the increase is a proof for Keynesian economics and that the “short-run benefits from the new phone have almost nothing to do with how good it is.”

Even if Keynesian economics were completely wrong, economists would expect the iPhone 5 release to cause consumer spending and gross domestic product to be greater than it was before the release, to a degree related to the phone’s overall value to consumers. Note that, as in my island economy, the development of Apple products reduces consumption before the release, because the people working on the coming products are not available to produce consumer goods during that time.

Much of the development work on the iPhone 5 did not, before its release, count as investment or G.D.P. (G.D.P. is the sum of public and private consumption and public and private investment). The national accounts treat research and development activities as intermediate inputs, which means that they are subtracted from revenue for the purpose of determining a corporation’s contribution to national production.

This same is true for, say, Apple’s legal expenses in developing patents (many of which are discussed on the Mactech Web site) and license terms for their new product.

These development activities appear as G.D.P. only when the product is completed and sold. If the product is not valuable, it will not sell and will not count for much, although national consumption could still rise if upon project completion the developers move out of development and into the production of consumer goods.

(Research and development employees usually receive wages during the development phase, but their prerelease compensation comes out of corporate profits).

For the purposes of understanding the timing of economic activity, the national accounts’ treatment of research and development is a weakness, because it recognizes the developers’ activity at the wrong time – only after the product is released. Economists at the Bureau of Economic Analysis (the agency producing our nation’s accounts) are aware of this weakness, how it has become acute with the rise of the technology sector and steps they might take to improve the accounts. They are doing the best they can with the data and economic research results that are available.

Measured consumption rises in the quarter when people buy their new iPhones, not when they actually use them (in my island model, the consumption would be measured when the apples are bought, not when they are eaten). IPhones are durable goods that are used for years after Apple sells them as new, including by second and third owners.

Curiously, the timing of measured iPhone consumption would be markedly different if Apple or cellular carriers had chosen to rent the phones rather than sell them, because the measured consumption would occur each month when users paid their rental fees (the Bureau of Economic Analysis is aware of this weakness and rectifies it in sectors where it is most acute, like the housing sector).

The iPhone 5 release is no occasion to cheer for wasteful government spending, but perhaps does help make the case for a larger budget at the Bureau of Economic Analysis, so that it can continue its progress on measuring the amount and timing of economic activity.

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.