Economic Models Mislead

by Samuel R. Staley

Mercatus Center economist (and frequent Corner contributor) Veronique de Rugy has an excellent critique of economic forecasting and modeling in the June issue of Reason magazine. She tears into how these models are inevitably biased in favor of government spending and lays out the key assumptions in a very accessible way. Models (and forecasts) are not reality, and too often these econometric studies confuse more than clarify. For example, Veronique writes:

All these analysts also systematically ignore the fact that GDP numbers include government spending. When the federal government pumps trillions of dollars into the economy, it looks as if GDP is growing. When government cuts spending—even cuts within the most inefficient programs—aggregate GDP shrinks.

But that’s misleading. If Washington spends $1 a year on a bureaucrat’s salary, for example, GDP numbers will register growth of exactly $1, whether or not the employee has produced any value for that money. By contrast, if a firm pays an engineer $1, that $1 only shows up in the GDP if the engineer produces $1 worth of stuff to sell. This distinction biases GDP numbers—and the policies based on them—toward ever-increasing government spending.

— Samuel R. Staley is Robert W. Galvin fellow and director of urban & land use policy at the Reason Foundation.