The San­ders case for more spend­ing and faster growth

The Pak Banker - - OPINION - Noah Smith

THE stan­dard case for fis­cal stim­u­lus goes like this. In a re­ces­sion, ag­gre­gate de­mand falls -- ev­ery­one is afraid to spend and in­stead just hoards cash. If the govern­ment spends it can prompt peo­ple to buy more things with the money they get from the govern­ment, which raises de­mand and gets the econ­omy work­ing again. Of course, this costs money, but the govern­ment can bor­row the money and pay it back the next time the econ­omy is run­ning on all cylin­ders.

Stim­u­lus, in other words, is part of a short-term strat­egy to fill in the gaps in the econ­omy caused by the busi­ness cy­cle. That's the ba­sic idea pro­moted by the in­ven­tor of the con­cept, John May­nard Keynes. It is also the story em­braced by most mod­ern pro­po­nents of stim­u­lus, such as Paul Krug­man. How­ever, in the re­cent de­bate sur­round­ing the eco­nomic pro­pos­als of pres­i­den­tial can­di­date Bernie San­ders, a small num­ber of econ­o­mists have started sug­gest­ing a very dif­fer­ent jus­ti­fi­ca­tion for stim­u­lus. Their idea: Stim­u­lus does some­thing more fun­da­men­tal to the econ­omy by rais­ing long-term pro­duc­tiv­ity.

It started with a pa­per by econ­o­mist Ger­ald Fried­man of the Univer­sity of Mas­sachusettsAmherst, which an­a­lyzed San­ders' eco­nomic plans. San­ders wants a lot more govern­ment spend­ing; Fried­man says that this spend­ing will raise growth so much that the pro­pos­als will pay for them­selves. Though Paul Krug­man, Aus­tan Gools­bee and other econ­o­mists have ridiculed this plan as beingim­plau­si­ble -- the mir­ror im­age of failed Repub­li­can prom­ises that tax cuts would be self-fi­nanc­ing -- there have been a num­ber of de­fenses as well, in­clud­ing some from very un­likely sources. If Fried­man and oth­ers are right, it would up­end most of main­stream macro, and would force a dra­matic re­con­sid­er­a­tion of eco­nomic pol­icy.

But Fried­man's pa­per seems far-fetched be­cause the nor­mal ac­tion of stim­u­lus -- putting un­em­ployed peo­ple back to work -wouldn't be nearly enough to cre­ate the kind of growth Fried­man projects. In ad­di­tion, we would need a huge boost to the growth rate of pro­duc­tiv­ity. Usu­ally we think of pro­duc­tiv­ity gains as com­ing mainly from tech­no­log­i­cal ad­vance­ments, some­thing that is very hard for govern­ment pol­icy to af­fect.

The no­tion that fis­cal stim­u­lus, in ad­di­tion to rais­ing em­ploy­ment, also boosts pro­duc­tiv­ity growth was first sug­gested in 1949 by a Dutch econ­o­mist, Petrus Jo­hannes Ver­doorn. Ac­cord­ing to what's known as Ver­doorn's law, all you have to do is boost gross do­mes­tic prod­uct growth -- for ex­am­ple, by fis­cal stim­u­lus -- and pro­duc­tiv­ity will soar as well. Fried­man ex­plic­itly as­sumes in his pa­per that you can do this. John Jay Col­lege pro­fes­sor J.W. Ma­son has long en­ter­tained the pos­si­bil­ity. The idea has even gar­nered sup­port from Narayana Kocher­lakota, for­mer pres­i­dent of the Fed­eral Re­serve Bank of Min­neapo­lis. Kocher­lakota -- a fa­mously open-minded econ­o­mist who changed his view about mon­e­tary pol­icy in re­cent years -- writes that there is "an em­pir­i­cal ba­sis" for Ver­doorn's Law:

The most strik­ing ev­i­dence [ for Ver­doorn's law] comes from the Great De­pres­sion in the US. To­tal fac­tor pro­duc­tiv­ity fell dra­mat­i­cally at the be­gin­ning of the De­pres­sion...Over the fol­low­ing three years, in con­junc­tion with the var­i­ous forms of de­mand stim­u­lus un­der­taken by the Roo­sevelt ad­min­is­tra­tion, TFP grew more than 5% per year faster than nor­mal. This su­per-nor­mal growth rate of TFP was a key con­tribut­ing fac­tor to the near dou­ble-digit an­nual growth in real GDP from 1933-37.

This seems to be il­lus­tra­tive of a more gen­eral and sys­tem­atic pat­tern...a fall in the un­em­ploy­ment rate of 1 per­cent­age point is em­pir­i­cally as­so­ci­ated with a 0.9 per­cent­age point in­crease in TFP growth. Econ­o­mists have long noted the rapid pro­duc­tiv­ity growth dur­ing the De­pres­sion. This is usu­ally con­sid­ered to be co­in­ci­den­tal -- the stan­dard story is that hu­man­ity just hap­pened to in­vent a bunch of use­ful stuff dur­ing the '30s. But Ver­doorn's law says that no, it was Roo­sevelt and his stim­u­lus that raised pro­duc­tiv­ity. If that's cor­rect, then stim­u­lus be­comes a much more im­por­tant tool, since its growth-boost­ing power would be much larger than com­monly as­sumed even by stim­u­lus pro­po­nents like Krug­man.

But there are a cou­ple of big prob­lems with Ver­doorn's law. First, cor­re­la­tion doesn't equal cau­sa­tion; as we found in the '70 with the Phillips curve, which said that as un­em­ploy­ment rose in­fla­tion would fall, try­ing to treat sta­tis­ti­cal cor­re­la­tions as laws of eco­nom­ics of­ten fails. It's ob­vi­ously pos­si­ble for fast pro­duc­tiv­ity growth to cause fast eco­nomic growth, rather than the other way around; if a lot of new tech­nol­ogy gets in­vented, busi­ness will want to in­vest and use it to take ad­van­tage of the busi­ness op­por­tu­ni­ties that re­sult.

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