Skip to comments.(Vanity) The Multiplier Effect, or, Stimulate This! (Why Adam Smith Only Uses One Hand)
Posted on 02/15/2009 9:25:04 AM PST by grey_whiskers
With the debate over the "Porkulus" bill in Congress (or, as I like to call it, "Pork and Awe"), there has been a great deal of related discussion over why the bill will work, or won't work, to stimulate the economy and create much-needed jobs and economic growth. However, much of the debate has devolved into partisan bickering. It might help to take a step back, and consider the differences between government and private spending in a more general sense.
To begin with, what does the stimulus package claim to do? Apparently, it authorizes the government to spend money, in order to put people to work doing such things as (to name a few)(*):
Besides being the fulfillment of liberal pipe dreams, what do all of these things have in common? There are two items which come to mind immediately. First, they are things which people on their own would not pay for. Second, they represent pouring of money down failed businesses in an attempt to keep them afloat -- good money (though that is becoming debatable) after bad. These two items are in fact connected; and in fact, the connection is underscored by the fact that many parts of the bill contain little or no funding on oversight to prevent waste, fraud, and abuse. More on this later.
"Great," you say, "so government wastes money. Tell us something we don't know. Besides, isn't it important to get people working again? We are facing what could be another Depression, so 'we have to do *something*'TM
The idea is, think back to the WPA during the real Great Depression. Public works projects are things which private people won't pay to have done. And many of them are, in effect, paying one set of people to dig a hole in the ground, and paying another set of people to fill the holes up again. The idea is, this way, money is being introduced into the workers' pockets, and they will spend money, which will increase the velocity of money in the economy, which is good for all of us.
But we need to re-look at this. If you pay people to do these things, sure, they will have money. But what will the results of their labor be? In the example of the hole, literally nothing. In the case of these examples, you will have a bunch of stuff that people don't want. (If they had wanted it, you see, they'd have paid for it already.(**) ) And so the net effect will be that of printing money and putting into circulation, with no corresponding increase in the number of useful goods or services to "soak up" the money. The net result is inflationary.
All this is old hat, and fairly obvious, if not often stated plainly. But there are a couple of other effects. First of all, the old joke,
Q. "How many people work for the Social Security Administration?"
A. "About half of them."
The problem is, that when government projects fail, there is no free-market mechanism for them to be eliminated, and thus free up their resources for more productive uses. Instead, there is the problem of perverse incentives--the idea that "this project is failing, so we need to throw more money at it." This in fact is the multiplier effect within government: the people allocating the money are not playing with their own money, but with other peoples' money: and Milton Friedman has already described what that leads to. And with government, it is not just the waste of the original money, but the temptation to encourage scope creep, because the business of government is government: if a problem is solved, then all those bureaucrats and their dependents ("it's for the children") will be out of work, and have to get real jobs. And we can't let *that* happen! So government, once started, tends to metastasize like a cancer: it grows without bound until the death of the organism.
By contrast, look at Adam Smith's "hidden hand". The reason free markets work, is not that it leads to "more money changing hands". The money changing hands is a by-product, or a signal, that people are busily engaged in producing things that are wanted, and then exchanging the things they have produced, for other things which they themselves want. It's a win-win situation: if you reward something, you get more of it. So people produce more things which are useful, beautiful, labor-saving, enjoyable, not by edict, but because they are rewarded for doing so. The stimulus is automatic: and if someone produces too much of something, well beyond demand, then they lose their initial investment when nobody buys the excess. So no "oversight" is necessary (barring a trust or a monopoly -- and the government *is* a monopoly, which is why they need oversight). They then turn their efforts to finding something else to make which will reward them.
And so this is the difference between the government and the Free Market: the government takes by force, to create things of dubious value, or to produce good things inefficiently--but the only thing multiplied is bureaucracy. The Free Market, on the other hand, rewards people for producing more than their own needs, in order to supply other peoples' wants. And since *everyone* wins, those who do end up making other people happy end up producing more, and doing so more efficiently -- because they are rewarded *for* success, not merely for being there. This is the multiplier effect, since each person in the economic chain has an incentive to do better.
And that is why Adam Smith only uses one hand.
(*) There *are* a few good things in the bill, such as $1.5 billion for new facilities for the NIH, provided they continue to fund decent research (rather than politically sponsored hack 'research' such as underlies other subjects like "global warming" -- so I'm reserving judgment on those parts of the bill.
(**) There would be an exception here for such things as the CDC, or nuclear subs, or the Interstate Highway System -- things which are so large, cross so many juridictions, or involve national security, that private enterprise cannot or should not provide for them. In fact, there is a good case to be made that the best use for government spending *is* to allow for what economists call "externalities" -- e.g., health and safety regulations, pollution, public safety. The difficulty, as noted above, is that there is no effective feedback mechanism to prevent the growth of Leviathan.
Statists love to talk about the multiplier effect of government spending. They refuse to acknowledge it works in the opposite direction when you lose all the good things that dollar you sucked out of the productive economy could have grown into.
Well said Whiskers.
Pray for America
No dollar ever taken up by govt. and returned to the private sector comes back as a dollar - it comes back as a fraction of it. My guess would be about 3/5ths of a dollar comes back into the economy.
After this bill starts taking affect my guess is the fraction will be down to about 2/5ths.
Your thinking of it all wrong and the government is marketing it all wrong. They’re not actually sucking “productive dollars” out of something else. They’re “generating wealth” out of nothing like the Wall streeters do.
“Pork and Awe”, I like that. The whole bill is pretty much a carpet bombing of good and bad ideas isn’t it.
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