It is virtually impossible to pick up a newspaper without seeing Mark Zandi — or, as he is invariably identified, “Mark Zandi, a former adviser to John McCain” — extolling the virtues of government spending.
Zandi is worried that Republican plans to cut $61 billion in government spending this year — 1.7 percent of this year’s federal spending, 3.6 percent of this year’s deficit — will result in the loss of 700,000 jobs, and reduce economic growth by half a percentage point. This makes him a favorite among those who do not wish to see federal spending reduced.
But before we get too excited, let’s put Zandinomics in a bit of perspective.
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First, we should dispose of the notion that Zandi is some sort of conservative Republican by virtue of his work for John McCain’s presidential campaign. It is true that Zandi was one of a number of economists from across the political spectrum whom McCain’s presidential team consulted for analysis of economic and business events, but he was never involved in formulating policy for the McCain campaign. In fact, Zandi is a registered Democrat, one who holds decidedly liberal political and economic views.
Second, Zandi’s record of forecasting is not unblemished. For example, in 2008 he was bullish about prospects for a recovery in the housing market. And he was one of the chief advocates of Obama’s stimulus plan, promising that it would create millions of jobs.
Zandi’s current prominence is based on an economic simulation he developed, allowing him to plug in government policies and report quotably precise estimates of how those policies will impact economic growth and job creation. But Zandi relies on an old-fashioned Keynesian economic model under which government spending creates a large “multiplier effect” that inevitably leads to growth.
Under this model, if government spends $1 billion to build a new bridge, the money doesn’t just disappear; it is used to pay wages to the bridge builders, buy steel, and so on. The bridge builders and steel suppliers in turn spend their income, raising consumption and creating demand as the money cycles through the economy.
If the multiplier equals one, then each unit increase in government purchasing leads to a unit increase in GDP, and government spending is essentially free. The government can build a bridge or invest in “green energy” without reducing anyone else’s consumption or investment: It’s a free lunch.
But Zandi goes even further. In his model, the multiplier is greater than one. This means that when government builds that bridge, not only does the bridge not really cost us anything, but building it generates additional resources that we can use to stimulate private consumption and investment: The free lunch includes a free dessert. In fact, the logic of Zandi’s model holds that government spending is such a good deal that it doesn’t matter if we needed the bridge in the first place; we should keep building it, tearing it down, and building it again, to multiply the money we are spending. From Zandi’s point of view, former Alaska senator Ted Stevens’s infamous “bridge to nowhere” wasn’t pork — it was a brilliant investment, and we should have built ten of them, or a hundred.
Of course, Zandi’s premise is simply a restatement of the ancient “broken-window fallacy,” an economic error refuted by the economist Frédéric Bastiat in 1850. In Bastiat’s parable, a shopkeeper’s careless son breaks a pane of glass in his father’s store. According to the economic theory popular at the time, that was actually a good thing, because it meant that the shopkeeper would have to pay the glazier to repair the window. The glazier then would use his new income to buy a pair of shoes, and the shoemaker would spend the money, etc. The cycle continues, and the economy is stimulated. As Bastiat notes, “You come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it.”
But as Bastiat pointed out, that leaves out an important calculation: what the shopkeeper would have done with the money had he not been obliged to buy a new window. “It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another,” Bastiat wrote. “It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.” The accident only means that the shopkeeper has spent six francs to bring himself back to the economic state he was in before the window was broken; he is no richer for it, but six francs poorer.
Zandi ignores the way in which government spending, taxes, and borrowing squeeze out private consumption and investment — what we might have done with the money had it not been taken by the government to build bridges to nowhere. And he ignores the need for economies to create new wealth rather than to simply redistribute existing wealth.
Winston Churchill once noted, “However beautiful the plan, one should occasionally look at the results.” However elegant Zandi’s model, we have not managed to spend our way to prosperity. On the other hand, we have managed to accumulate enormous debts that threaten to bankrupt our children.
Zandi is wrong — spending is not our friend. It’s time to cut.
"In fact, the logic of Zandi’s model holds that government spending is such a good deal that it doesn’t matter if we needed the bridge in the first place; we should keep building it, tearing it down, and building it again, to multiply the money we are spending. From Zandi’s point of view, former Alaska senator Ted Stevens’s infamous “bridge to nowhere” wasn’t pork — it was a brilliant investment, and we should have built ten of them, or a hundred."
This is the situation that I have always wondered about Keynesianism. If government spending is always optimal, then all government spending, regardless of what it is spent on, is optimal to that what is done in the private sector. In other words, it is no longer surprising that many people who believe that government spending is optimal should also believe that the wages and wealth of citizens belong to the government. Any spending that is cut by the government is necessarily harming the nation because government spending is what is keeping the economy afloat.
What happens when there is no more money for the government to spend?
In for a penny, in for a pound. Zandi said in an NPR interview in the spring of 2009 that if job loss numbers aren't going down by summer the stimulus isn't working.
The refutation of Zandi's "Spend More!" argument and all other Keynesian cries for still more federal spending is elementary. Just ask what the politicians plan to do with the resources. Will they be spent or invested in ways that will help to create more wealth in the future? Or will the money be squandered on innumerable boondoggles that help make politicians look popular in the short run? The federal government can no more make the nation more prosperous by borrowing so politicians can continue their spending binge than a family can make itself prosperous by borrowing money to buy booze, junk food and video games.
Actually, the multiplier for government spending is something less than 1. In order for the government to spend a dollar it must first take that dollar out of the economy. The dollar the government extracts from the economy would be more economically productive left alone satisfying real demand than being diverted to an artificially created demand identified by the government.
It seems to me that the Keynesian multiplier must always be less than one. People tend to save some part of incoming cash for a "rainy day" fund. Only if they have plenty of rainy day money would they tend to spend it as fast as it comes in. And if they have plenty, then they wouldn't need the government to be spending money. And that doesn't even figure in how much the government keeps to pay the people handling the financial transfer, "and for other purposes", as legislation says.
Hey, I'm no Econ expert, but I do recall from an Econ 201 (Macro) course in 1973 that there is something called the velocity (turnover) of money; and that when the Gubment gets money, the velocity factor slows down (as opposed to it regularly circulating over and over in the private economy).
Never hear much anymore about M1, M2, M3, etc, and the velocity of money.
Sadly, the problem is not limited to Zandi. The entire Democratic Party is fully committed to Keynesian spending.
Clearly, experience has proven that the multiplier is ALWAYS less than 1. Depending on how the money is spent, the multiplier may in fact by 0 or very close to it.
For instance, much of the "Stimulus" money went to state governments that used it to reduce the amount of money they were borrowing (to maintain current spending levels despite lower tax receipts during the recession). The Feds were borrowing the money in the first place. So, what's the multiplier of having the feds borrow money rather than states? Zero.
The velocity of money isn't relevant. The Germans had a fantastically high velocity of money during the great inflation of 1922-23. People spent money as fast as they could get it, but less and less was being produced for them to buy.
That's the crucial point. Prosperity comes from using our limited resources as productively as possible. We know that free market competition under the rule of law and no government subsidies or bailouts or other interventions that upset rational economic calculations is what promotes maximum productivity. We also know that when politicians divert resources into their pet projects, to the care and feeding of special interest groups, to the enforcement of laws and regulations that hinder businesses and impede entrepreneurship and so on, the result is reduced production and further waste of resources on lobbying and political campaigns.
I think it's worth noting that the usual defenders of the mega-state are quiet on this issue.
If it is the case that spending money creates more money in the economy (the bridge builder buys food, from the grocer who buys clothes, from the seamstress who buys... etc.), then what are we to make of the current administration's zeal for borrowing gargantuan sums of money to pay for this economic stimulation? Sure, you currently would multiply the amount borrowed in the economy through this route, but you have to pay it back in the future, which pulls money out of the economy at that point (and the amount of negative economic stimulation would also be multiplied in a wave through the economy for the same reason). Not only that, you have to pay it back with interest (the effects of which also multiplies), so the damage done is greater than borrowing in the first place. I guess the idea is either that 1) the impact will occur after the current administration is gone or 2) that we place our hopes on an unusually bright point in the near future where the economy "needs" to be substantially cooled down. But that seems to be a bit of wishful thinking, kind of like throwing in your month's paycheck to gamble on a hand of poker on the assumption you will make alot more in a big win than what you are putting into the pot.
I went to a talk by Zandi last year at the Union League Club in Philly. He talked about how the first stimulus was "good policy" and "Necessary". At the time Congress was debating a second stiumulus package, renaming it a "jobs program" . The first question in the q and a was, "What is your biggest concern at the moment". His answer, I am not kidding was "the fact that nobody is hiring"!!! So much for Zandinomics.
I can't believe how little economics this author and the commentators know. Government spending only crowds out investment and consumption if there is no idle resources and the crowding out occurs due to rising interest rates. But when we do have idle resources, increases in government spending will increase output/growth and this will lead to crowding in (and increase in investment. Keynes didn't say increase in government spending is always optimal, it is optimal during economic downturns and especially during financial collapses that cause a liquidity trap
Arradin: At the absolute best, the multiplier for govt spending is zero.
The multiplier for a dollar spent by govt must be the same as a dollar taxed or borrowed by govt. The good, if any, done by the dollar spent is matched equally by the dollar extracted from the economy.
Brian, you castigate others for economic ignorance, but then you blaze gloriously forward to display your own.
First off, idle capital is an invention of the left in order to justify taking money from those who earned it.
Secondly, even if there were idle capital, and money spent by govt would immeadiately return to that pool of idle capital, once again having no impact on the economy.
Zandi is a much confused economist. I heard him opine on MSNBC that there was no difference in economic effect between deficit spending and tax cuts...unbelievable. His profile is far too high for his limited intelligence.
This is really no different from Keynes's assertions. Keynes believed that the government project money could be spent on anything, productive or not, and it would still result in the multiplier effect. The important thing was to get capital moving in the economy. His entire assertion was based on the Broken Window Fallacy; that, and his refusal to believe that gold had any intrinsic worth. This lead to all manner of strange assertions, such as the printing of new money by itself creating new capital in an economy. If gold has no intrinsic value, but you choose to pretend that it does, then all of this logically follows.
The multiplier effect not only ignores the alternative uses to which that money may have been put; it also ignores the loss of a portion through its bureautratic transfer and the fact that public money may be spent for political reasons as well as economic ones. Keynes's proposition was simply that money was not moving in the economy because the owners of it were holding on to their wealth, therefore any method which would get the money in circulation would be beneficial. He didn't consider the reasons for holding on to money to be valid. This was the man who insisted that interest rates were arbitrarily too high when there wasn't a central bank to set the prime lending rate.
Markw, I don't think you understand the difference between capital and money. Money is never productive, pieces of paper and numbers in a ledger do not produce anything. Capital is used in the production of goods and services.
Mark Zandi comes up with his estimations of the multiplier by looking at the data, not some story of that it has to be offset by something else. When a private firm builds a new factory, that is not taking money from somewhere else and thus output does not go up. When a private firm builds a new factory, output goes up
All levels of government account for 46% of our total GDP of $14.2 trillion by spending $6.7 trillion of which they have much less than this in actual revenues. The private sector spends $7.5 trillion.
This is not all cash from payroll and taxes, much of this GDP figures comes from credit cards, mortgage debt, deficit spending, loans.
To think that spending more by government than it takes in with total revenues when it already has $14.2 trillion in debt and $112 trillion in unfunded entitlements is absurd.
Do not forget that between our trade deficit and oil imports we also send another $1 trillion dollars every single year out of our economy beyond what returns from abroad.
The only solution is deep and heavy government spending cuts and reduction of government as a whole. For every 5.1 tax payers, there is 1 government employee. It is no longer Public Servant, but Public Master.
By the next Congress government will exceed 50% of GDP. Anyone that thinks government spending spurs growth in any situation needs their head examined. This is not WWII, they did not start with $14 trillion in debt, they did not owe $112 trillion in unfunded liabilities, they did not have 1 government employee for every 5.1 taxpayers.
There is only 1 solution. Across the board deep cuts, eliminate entire agencies, privatize institutions such as education, create the flat tax and reduce the IRS by 90%. Reduce military spending by creating pilotless aircraft as to safe on all of the safety and life support and training expenses, same with tanks. You would end up with a much more powerful military for a fraction of the cost.
Don't do these things and we won't have to debate after 2020 as global economic death spiral will be experienced by each of us.
