Friday, January 21, 2011

Is The Onion Channeling J.M. Keynes???

The Onion "reports" that a "Revamped WPA will Create 50,000 New Jobs by Disassembling, Reassembling the Hoover Dam." The story also reports that other "public works" projects are on the way, including:

"the bulldozing of libraries, the burning of national forests, and the defacing of public murals, which will be followed by a massive plan to rebuild libraries, revive national forests, and repaint public murals."

While styled as a spoof, the piece captures the essence of Keynesian stimulus theory. That is, when the economy is operating significantly below full employment because private consumption and investment are lagging, the government should borrow from its citizens and spend the proceeds by buying goods and services in the domestic market. Under this approach, it does not matter WHAT government buys; so long as the government purchases something it will stimulate aggregate demand and thus Gross Domestic Product, so long as the nation's aggregate supply curve displays some elasticity. (Technically, macro-economists would model this impact by shifting the aggregate demand curve up and to the right.) Thus, Keynes himself argued that the State could stimulate the economy by paying its citizens to dig holes in the ground and retrieve objects buried there:

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. "

Of course, many Americans would criticize the sort of spending that Keynes identified as wasteful. However, let's assume for the sake of argument that this sort of spending would stimulate the economy when unemployment is high, as Keynes argued. Would such an expected effect justify such spending as a matter of policy? Probably not --- even for Keynes. For, as Keynes himself says in the language quoted, there would be more sensible means of spending the money in question, that could have the same stimulative effect. One could, for instance, spend the money on infrastructure projects --- roads, ports, bridges, airports and the like ---that enhanced that nation's productivity. Even Adam Smith recognized that spending on infrastructure was an appropriate role of the state. As he put it:

"The third and last duty of the sovereign or commonwealth is that of erecting and maintaining those public institutions and those public works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature that the profit could never repay the expense to any individual or small number of individuals, and which it therefore cannot be expected that any individual or small number of individuals should erect or maintain."

One could also spend such money on research and development, for instance, producing the sort of basic knowledge that the private market might not otherwise produce, because certain types of discoveries are (properly) not patentable under federal law. If focused on the right projects and research, such spending could increase the potential output of the overall economy, a result that economists would model via a shift in the long run aggregate supply curve to the right.

Of course, the argument and rationale for spending on public works and research and development applies regardless whether the nation is in a recession. However, the argument might be stronger in a recession because: (1) such expenditures might help stimulate aggregate demand, as explained above and (2) the cost of such projects will likely be lower during a recession, as labor and capital stand idle because of reduced economic activity.

In short, while borrowing and spending on any number of activities might stimulate the economy in the short run, spending such money on projects that build infrastructure and create knowledge can enhance the nation's prospects for long term economic growth. In other words, as previously discussed on this blog, not all stimulus spending is created equal.