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May 11th 2009 print

James Guest

Debating Steven Kates

On Rudd’s cash handouts: “It is a budgetary matter. Some people, including many recipients of today’s handouts, will pay a little more tax in later years, or suffer a little from the RBA allowing government a little more inflation to make discharge of debt easier.”

[Steven Kates responds to this essay here]

It is a pity to find myself again (see Letters in May Quadrant) wishing to quibble with the opinions of a good Dry economist like Steven Kates who seems to share the well justified suspicion that governments will usually waste our money – and that’s so even when they are trying to do good things. What is more he is now coming round to saying that what really matters is that the governments which believe (and Kates fears) that they are re-embracing Keynesianism make good productive investments. Fair enough, but not enough, because he could send mere politicians seriously astray - imagining that they are heroic Austrians (by Hayek out of Chicago) – by failing to distinguish between consequences for budgets and consequences for the real economy. 

Here is part of Kates’s online follow up to his March 2009 Quadrant article “The Dangerous Return to Keynesian Economics”: 

It is clearly difficult to get the message across that spending money on anything at all is not the road to growth. If all that was needed to cause an economy to create productive jobs was for the government to increase its levels of debt and spend on the first thing that came into its mind, then economic management could even be done by clueless hacks with no economic credentials to their name. 

But unfortunately for us all, spending on unprofitable projects puts us into collective debt and then afterwards requires many years to pay down whatever it is a government may have chosen to buy. 

Here’s the deal. Spending money does not itself create growth. I know that the way economics is now taught, that is the impression one might get from a first year course, but for all that, it isn’t true. 

It’s not the spending that creates value, it’s what the money is spent on. Because unless what the money is spent on does add more value than it uses up, the economy, far from growing, will have gone backwards. Such spending slows the economy rather than speeds it up. 

Kates has already made it clear that he does not regard insulating houses or building school libraries as qualifying though his condemnation of proposed spending on the National Broadband Network seems to be as reckless and unfounded in anything but rhetoric as Rudd’s proposal of it. He continues

The $64 billion question is this: whether the things that are being built are going to produce more value than the value used up in their production. 

If it does, bravo, we are all ahead. The economy has been allowed to grow. 

But, on the other hand, if the value created by all this spending turns out to be less than the value we have used up, then the economy is worse off than when all this spending began. 

Nobody has much idea what all those multiples of $900 handed out before Christmas were spent on or, if saved, what they will be spent on later this year or next. We can be very sure that it wouldn’t pass the cost-benefit test that Kates rightly wants to apply to the national broadband plan. But there is not the slightest reason to suppose that it has harmed the economy or will one day be proved to have done so. Essentially it is a redistribution of income. It is a budgetary matter. Some people, including many recipients of today’s handouts, will pay a little more tax in later years, or suffer a little from the RBA allowing government a little more inflation to make discharge of debt easier.

Any expenditure by government which leads to people being employed rather than receiving unemployment, disability or old age pension benefits will be beneficial to the economy unless it crowds out more productive employment, which is most unlikely for the next few years, or is such incompetently expensive make work that the costs to real taxpayers mean that their truly productive investment ideas cannot be afforded or will not, as a matter of discretion, be implemented.

$43 billion on a broadband network committed now and spent over years when near full employment is restored could result in a very big loss to the economy if it is only worth $10 billion as a commercial project.

The insulation plan, so easily derided, is not like that. For quite a lot of people it will save worthwhile amounts on their heating and cooling bills and it could help offset some of the costs that result from Australia agreeing to reduce CO2 emissions. The net present value of such benefits is not likely to be great at any appreciable real interest rate (which Australians will always have to pay, unlike the printers of the world’s reserve currency) but even if it were negligible there would be people employed by the contractors and taxes paid on both wages and profits as well as GST. If the program were using resources which would otherwise be used in a more productive way that would be a ground for criticising it but that is not likely to be the case because the contracts to insulate houses and the budget spending tap for them can be turned on and off very quickly. Like Keynes’s suggestions to Roosevelt that money be spent on overdue railroad maintenance, it makes very good sense when there is a recession of unpredictable duration. School libraries, and the increased grant to first home owners, offer much the same advantages, though not quite as easy to turn on and off as a way of spending money for actual work done compared with insulating houses.

The Nobel Prize winning economist Robert Solow made the distinction between the budget and the economy in reviewing Judge Richard Posner’s book A Failure of Capitalism: The Crisis of ‘08 and the Descent into Depression for the 14-27 May issue of the New York Review of Books in which Steven Kates’s name might in this passage be substituted for Posner’s:

There are other weaknesses in Posner’s remarks on the real economy. For example, more than once he says that the various antirecessionary measures—like fiscal stimulus, bailouts—are very “costly” and “may do long-term damage to the economy.” He does not explain what these costs and damages are. Sometimes he seems to have budgetary costs in mind. But bailouts are mostly transfers from one group in society to another, for example from taxpayers to financial institutions and their owners. They are certainly not ethically satisfying transfers, but it is not clear how they do long-term damage to the economy. The components of a fiscal stimulus package are costs to the federal budget; but to the extent that they put otherwise unemployed labor and idle industrial capacity to work, they do not impoverish the economy; in fact, they enrich it. (Of course, one would prefer useful projects to wasteful ones.) If fiscal stimulus works, even imperfectly, there is no doubt which way the benefit–cost ratio goes.

There are two earlier passages in Solow’s review which all those riding quixotically into battle against a Keynes of their imagination should ponder: 

Most commentary, at large, in Posner’s book, and in this review, has been about how the financial collapse damages the real economy. It might be thought that somehow fixing the financial mess would automatically fix the real economy. That is not so, for at least two reasons worth mentioning. In the first place, all that vanished wealth cannot be restored; much of it was fluff, as we now know. American families are not worth $64.4 trillion. There is no way to know now whether they are worth more than $51.5 trillion or less. 

Consider that in the context of this previous statement: 

Nothing concrete had changed. Buildings still stood; factories were still just as capable of functioning; people had not lost their ability to work or their skills or their knowledge of technology. But a population that thought in 2007 that they had $64.4 trillion with which to plan their lives discovered in 2008 that they had lost 20 percent of that. A standard, empirically tested rule of thumb is that an additional dollar of wealth induces the average consumer to increase annual spending by an amount between four and six cents. So we are looking at a potential drop in consumer spending of something like $650 billion a year (5 percent of $13 trillion). 

Consider that, because it makes it very clear why rational policy makers may think that Obama’s $800 billion package of expenditure over several years is hardly going to touch the sides.

James Guest writes that he “was a Founder Member of the Society of Modest Members, the Dries before Margaret Thatcher invented the term.”