The Microeconomics of Government Stimulus Spending and Why Bastiat Matters

Steven Horwitz, Ethics-Free Partisan Hack

"Mr. Keynes' aggregates conceal the most
fundamental mechanisms of change."
- F. A. Hayek (1995 [1931], p. 128.

Well, this has been an interesting week for me, suffice it to say.  Given all the commentary on my little blog post at Nightly Business Report, I figured it was time for me to respond.  Rather than respond to specific people, I just want to raise three points about all the commentary that's gone on.

First, if I had to do it over again, I would have given some subtlety to the sentence that seems to have set people off the most.  This sentence is the one in question: "For every dollar that government spends, there is one less dollar being spent somewhere else in the economy."  My posts for the NBR blog are limited to 500 words or so and are designed for the non-professional public.  If I had even a clue that the post was going to be the fodder of conversation in major economics blogs, I surely would have phrased that with additional precision. Mario Rizzo's comments today rightly describe that sentence as not perfect but "as a statement of the long run, it is not bad." In the context of that sort of blog post, I don't think the sentence is worthy of charges of professional malpractice, but were I in a graduate seminar or knowing where it's gone since, I would have been more wordy and precise.  If imprecision and unsubtlety are professional crimes when talking to non-economists, you better come drag me out of my intro classes. 

Second, it's interesting how much attention the second half of the post got and how little the first half did.  I was trying to squeeze two big points into 500 little words.  The one that everyone jumped on is the broken window argument (to which I return momentarily).  The other, however, was that the jobs that are being created by the stimulus spending might well be wasteful (as in the Chinese workers with shovels or spoons).  The two points are connected, as I'll argue below. When one gets beyond the typical aggregative thinking that infects most macro, the important question is not "how many jobs?" but "which jobs?"  Jobs are easy to create;  the right jobs are not and require the distributed intelligence of the marketplace. 

This problem is magnified when we take seriously the heterogeneity of both capital and labor and that the "right jobs" will be the ones that fit with the structures of human and non-human capital available to be worked with.  When the focus is on the number of jobs and the resulting, hoped-for, increase in GDP, then it doesn't matter what labor and capital is activated.  Any ol' jobs and capital will do for increasing GDP (or reducing unemployment!).  But when the focus is on, oh say, economics as a coordination problem, then it matters a lot what the microeconomics looks like.  (In fact, I wrote a whole great big book on this topic published by a company that publishes real, actual economists, so I guess they're guilty of malpractice too.) 

Put differently:  it is not a priori true that the economy is "better off" by activating idle human and non-human capital just for the sake of generating wage and rental payments, as opposed to leaving them idle until they can find employment that enables them to complement the structure of production and produce goods and services that people actually want.  This process of "re-figuring out" what the post-boom economy should look like is what Arnold Kling has nicely termed "the great recalculation."  The stimulus and the bailouts and all the rest cut short the social (re)learning process that is necessary to a sustainable recovery from the boom and resulting bust. 

I will add that my focus in the original post was only on fiscal policy not monetary policy.  Thus Bill Woolsey's comments over at ThinkMarkets would require a different conversation.  All I'll say here, at the risk of now pissing off some Austrians, is that for the "great recalculation" to work effectively, the money supply needs to be sufficient enough to prevent MV from falling but not so great as to restart the inflationary bubble.  Whether current policy is right or not will have to wait for another day.  For the purposes of that post, I was focusing only on fiscal issues.

Bottom line:  even if it is the case that the stimulus is a net job creator, that hardly means that those jobs are using resources in the most valuable way.  And that leads us back to my third point: the relevance of the broken window.

The point of invoking Bastiat was not his numerous published pieces on the intricacies of cycles and bubbles (that was sarcasm for those who think I'm a clueless idiot about Bastiat), but rather to note that taking account of the unseen is never a bad idea and that, as many others have noted, recessions do not rescind the most basic ideas of economics.  Simply put:  if one takes seriously the considerations about markets, prices, and knowledge that define the Mises-Hayek approach to the microeconomy, one is likely to be very skeptical that government jobs programs will do a better job at finding the right jobs than will entrepreneurs using the signals of the market place.  This point is even stronger when we realize that really-existing stimulus programs, as opposed to the virginal ones on the blackboards of Very Important Economics Departments, are highly likely to be full of pork.  This, interestingly, raises the question of which economists supporting which policies are really doing the bidding of the partisans.

Even if the Administration's estimates of the employment effects of the stimulus programs are attempting to net out the jobs that are disappearing alongside them (as macro models might attempt), that does not address the more fundamental point about markets as discovery processes:  what Bastiat was really saying is that it's not a matter of the jobs "destroyed" but the ones "not created" because resources were diverted from the market to the political process (in this case). 

Note that I did not deny that government stimulus programs could, on net, create jobs.  I just said that "The result is that estimates of the net employment effects of government programs will always be biased in favor of the program's effectiveness."  Again, creating jobs is easy, but it shouldn't be the goal:  getting value-creating jobs should.  And creating jobs by government spending will happen at the same time existing jobs are destroyed.  Fair enough.  But the Bastiat point is that we cannot know how many jobs would have been created, nor which ones, if the resources devoted to the stimulus had been left in private hands.  And we do have reason to believe that those are more likely to be the "right" jobs, given the superior incentives and learning processes that characterize the market.  Thus, trying to count the number of jobs that a stimulus creates "will always be biased in favor of the program's effectiveness" not just because the "counting" ignores what can't be seen, but also because merely "counting" tells us nothing about the microeconomic coordination effects of the jobs created.  And those effects are likely to be problematic.

A simple point, really.  Not rocket science, that's for sure. 

I hope that this discussion helps to expand and clarify the Little Blog Post That Could.

Comments

[Bill Stepp]

Good response.
Even if government stimulus programs create jobs, they are jobs that satisfy the demand of politicians and bureaucrats, which is not the same as consumer demand. Presumably they need continuing political demand and government spending in order to exist. And rent-seeking is never mentioned by their supporters.
The WSJ weekend edition has an article "Opinions Split on Job Creation," which cites a CBO report claiming that the policies with the most effect on employment are lowering payroll taxes for firms that hire new workers, and increasing payments to the unemployed. How raising unemployment "insurance" payments (i.e. subsidizing unemployment) leads to more jobs is a head scratcher.
It mentions that employers "say they are basing hiring decisions on business fundamentals." As opposed to political pull. I'll take economic calculations over political calculations any day. The former might lead to innovation, fulfillment of consumer demand, and jobs that are sustainable. The latter is less likely to result in real jobs, and more likely to lead to rent-seeking, bridges to nowhere, and monuments
to corrupt (but I repeat myself) politicians.

[Marcus Nunes]

Steve
You wrote as an aside: "All I'll say here, at the risk of now pissing off some Austrians, is that for the "great recalculation" to work effectively, the money supply needs to be sufficient enough to prevent MV from falling but not so great as to restart the inflationary bubble".
In other words, for the system to be able to adjust, there must be a sufficient amount of "gas" in the tank for things to keep rolling. And between mid 06 and mid 08, when Nominal demand was growing satisfactorily, the adjustments (recalculations) were taking place. But "a crisis shouldn´t go to waste"...

[Ryan M]

To play devil's advocate, wouldn't a Keynesian say that the stimulus will come in primarily through one-off jobs like road construction, and that the increase in aggregate demand that results from the multiplier will bring about jobs matching the existing capital structure and consumer preferences? That is, the first round of spending maybe chosen bureaucratically and be abundant in pork, but, aside from wealth effects, the subsequent rounds of spending will be firmly in line with microfoundations?

[Mario Rizzo]

The comments from Brad DeLong continue at ThinkMarkets. I must say, however, that I have never mastered the art of mixing ad hominem and economics arguments. I usually follow Karl Popper and simply deal with the scientific issues. But perhaps every method meets its rhetorical match. (Excuse me for using the word "rhetorical" in this corrupt way.)

[liberty]

Ryan M makes an interesting point for at least a small portion of the "stimulus" spending -- but Ryan, a good part of the money went to "save" jobs, especially in the public sector, in newly part-public companies that were bailed out etc

Also, if we have spend $787 billion plus TARP and other bailouts and other pork projects, totaling somewhere between 1.5 and 3 trillion this past couple of years toward "stimulus" then the amount that must be crowded out of private sector investment is significant. Given that the spending was all directed by politics, whether short or long term it has increased demand in certain capital markets, kept certain resources tied up in the things that politics has demanded, and so forth.

As some examples - major housing re-inflation through the Christmas Eve F&F bill, the anti-foreclosure measures etc; the propping up of GM, the broader car industry, manufacturing jobs, public sector jobs, health care and education jobs, most other sectors that have strong unions, etc.

I've been looking at the composition of the job gains, comparing 2007 and 2009 but so far the aggregate data (slightly dehomogenized) does not show significant sectoral changes. Still, it is not always that easy to see the effects.

[Mario Rizzo]

A general point to keep in mind:

"It obviously endangers the freedom and the objectivity of our discussion if we attack a person instead of attacking an opinion or, more precisely, a theory."

-- Karl Popper

[Greg Ransom]

Well, yes.

It also endangers freedom and the objectivity of our discussions if we don't lay out the facts about who dealing honestly from a straight deck and who is lying and bullshitting everyone else -- e.g. it is VITAL to expose scientific fraud, as in the "climategate" case. Popper wouldn't have claimed otherwise.

Krugman openly endorses the scientific fraud of the climategate people, justifying it with the excuse that this just the behavior that is standard at the top of the economics profession.

It matters that Krugman and DeLong are dishonest people, and trade in bullshit and lies. Especially given that these folks are not only "scientists", they are also opinion leaders in the public debate.

Mario writes:

"A general point to keep in mind:

"It obviously endangers the freedom and the objectivity of our discussion if we attack a person instead of attacking an opinion or, more precisely, a theory."

-- Karl Popper"

[Jerry O'Driscoll]

Check out Glenn Hubbard's piece in today's Wall
Street Journal in which he offers an estimate of future crowding out.

http://online.wsj.com/article/SB10001424052748704041504575045250168889076.html

[Bob]

Steve,
Considering the fact that the "saved jobs" were state and local government employees and we all know how value destroying these jobs are to the economy, I think you proved your point!

[Barkley Rosser]

I'm sure we would have lots more people pumping gas and selling hamburgers at minimum wage, if only we would fire all those worthless school teachers cluttering up the state and local payrolls!

[discount coach]

In life, we need to know that don‘t waste your time on a man/woman, who isn‘t willing to waste their time on you.

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