Monday, September 15, 2008

Orthodox Keynesian Fiscal Policy

In discussing fiscal policy, many macroeconomics professors speak of increasing output without regard to what specific component of output is actually increased. Often they put forward the [ridiculous] position that digging ditches and refilling them is just as effective as building roads, bridges, dams, office complexes, or sports stadiums. All of these expenditures, after all, shift the IS curve to the right.

The absurdity of such a claim makes it easy to refute. But we should ask whether Orthodox Keynesians actually subscribed to this idea before relishing in the defeat.

As it turns out, James Tobin (arguably the most prominent Orthodox Keynesian) states that a consensus between Orthodox Keynesians and Neoclassicals existed in the late 1950s and 60s:
I thought that there was also a normative consensus, in the sense that you shouldn't regard any output that you get from putting unemployed resources to work as free, because you have alternative ways of putting unemployed resources to work. The same classical opportunity cost considerations that determine allocation of resources in a classical equilibrium determine the allocation of resources as among different ways of returning to that supply-constrained regime. So I think in that sense there is no excuse for wasteful projects to increase employment, like digging holes in the ground, because you can arrange to employ people by investments or other projects that are socially beneficial (Snowdon and Vane 2005, p 151).
It seems as if many arguments refuting Orthodox Keynesian fiscal policy are actually in refutation of a position held by no one.

Of course, the model makes no differentiation between one type of output and another: a change in Q is a change in Q. But if the consensus Tobin spoke of actually existed, there seems to be little practical value in further specification of the model.

Rather than continue to knock over a straw man, then, I suggest one accepts that no one actually believes that one government expenditure is just as good as the other. Instead, ask another question: how is government to know what expenditure is best? And if Mises and Hayek taught us anything through the socialist calculation debate, it is that only decentralized actors working within a price system can approximate the best use of resources.


Juris Naturalist said...

Well said Will.
I've just read "The Jungle," and the glaring error in that socialist propaganda was also economic calculation by centralized actors.

Will Luther said...

Stephen Baker via email:

If you want to go down the road of evaluating alternative types of spending, I would be delighted.

Dollars wasted on wars would be a good place to start. (Health care could be funded for a fraction of the military budget.) Conservatives like to condemn welfare, but there is a deafening silence on the corruption resulting from contracts awarded to friends of the Bush administration.

We also now have the principle that large financial companies can’t fail. Another waste of government money. As for the arguments being made currently that regulations are responsible for bad loans and the current credit crisis, I can only assume that the free choice argument has won in some areas and the people making such arguments are enjoying some really good dope.

Will Luther said...

I couldn't agree more about the Hawk fund. I find it very difficult to argue that destroying things with bombs can somehow generate wealth and prosperity.

I don't know much about the financial sector or how much regulation has played a role. But I expect future failures to result from bailouts, as financial firms make riskier investments in hopes of high profits and assured that failure is not an option. When the taypayers will take care of you, there is less incentive to take care of yourself. I believe this holds for multinational firms and uneducated single mothers.