Exclusive to this site, November 2, 2000

Where Have the Two Trillion Dollars Gone?
by
Pierre Lemieux

 

Because of lower government expenditures, there were more than two trillion dollars missing in the American economy during the third quarter. So do macroeconomic sorcerers say, followed by the press: “Much of the slower growth stemmed from an unexpected 3.6% drop in government spending” (Wall Street Journal, October 30, 2000). The implication is that, if government spending had not decreased, there would have been 10 million more cars produced, or 100 million more home computers, or $60,000 more in health care, beer and TV programs for each American poor.

For many decades after John Maynard Keynes’ 1936 General Theory of Employment, Interest and Money, economists thought that “aggregate demand,” the total of goods and services demanded on all markets, could fall short of aggregate supply, leading to unemployment and economic recession. In such an event, government could create prosperity just by spending.

“If the Treasury,” wrote Keynes, “were to fill old bottles with bank-notes, bury them at suitable depths in disused coal-mines 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 …, there need be no more unemployment and, with the help of repercussions, the real income of the community, and its capital wealth, would probably become a good deal greater than it actually is.” Conversely, if government spends less, real income and real production – what we now call gross domestic product, or GDP – decreases.

The question is, Where have these two trillion dollars gone? If the government did not spend them, the taxpayers must have. If they saved part of the money, these savings would have been lent to investors and spent by them. Or, in real terms, the resources that were diverted to produce goods for the government would have been used in the production of goods demanded by consumers and businesses. Keynes did have counter-arguments, but his theory was buried after the public expenditure growth and deficits of the 1970s produced both inflation and unemployment, up to the early 1980s recession. Keynes’ theory is now meaningless for virtually all economists – except forecasters.

Perhaps the evolution of GDP means something over the long run – for example, when comparing government share in GDP today (between 40% and 50% in most countries), with what it was a hundred years ago (around 10%). But quarterly growth rates carry hardly any meaning, because of both statistical and methodological problems. Actually, most macroeconomic aggregates, including the aggregate price level, have a dubious methodological standing, and divert our attention from the reality of acting individuals on specific markets.

Although economists may build theories to explain the business cycle, they are unable to forecast when boom will turn to bust, or the other way around. An economic forecaster is like a meteorologist who would try to forecast the quarterly and annual weather, in a system where the winds depended on people’s opinions, and where a God constantly intervened – worse still, an imperfect, government-like God whose actions had unintended consequences. If the past is any guide to the future, an economic downturn is looming, but it is not because two trillion dollars disappeared. There is an argument that more flexible financial markets as well as technological and institutional innovations have made recessions less likely, but don’t ask an economic forecaster.

Now, why do people (business managers, investors, consumers) attach any importance whatsoever to the short-run evolution of macroeconomic indicators like aggregate demand, the balance of trade, or GDP growth figures? One reason may be that people generally believe authorities, that macroeconomic statistics are produced by the state, and that economic forecasters are generally close to the establishment. Another reason may be that the unknown is frightening and numbers are pacifying, even if meaningless. I don’t know if I will sell my widgets, nor what is the meaning of life and death, but the economy will grow at 3.0% in 2001.

Perhaps, macroeconomic data are just a coordination device, helping to bring all opinions in line, and preventing bad forecasts and costly errors. One problem with this view is that the coordination mechanism is the free market itself, and one wonders what macroeconomic forecasters could do better.

Another problem is that macroeconomic data, assuming they describe some aspect of reality, relate to the past, while coordination deals with the future. Hence the role of the economic forecaster? No, for Keynes is dead and economic forecasters have no forecasting theory. Moreover, they often have perverse incentives: the individual forecaster minimizes his career risks by sticking close to “the consensus,” while most institutions employing forecasters (banks, government agencies, business think tanks, etc.) have a duty to be optimistic. When is the last time you read that the forecasters’ consensus was for a recession?

Besides being interested in the truth, why should we care about all this? Because, since Keynes, macroeconomic voodoo mainly serves to justify the intervention mystique, and the idea that the state creates economic prosperity by digging holes in people’s pockets.

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