The "multiplier" effect is often invoked to justify public spending - the idea that a dollar spent on a particular program increases the GDP by more than one dollar. Quoting Harvard economics professor Robert Barro:
To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy's total output expands by enough to create the airplane or bridge without requiring a cut in anyone's consumption or investment.
Some might remember invokations of the "multiplier" effect during the sports stadium debates in Seattle. Local economists were hired to argue that the "multiplier" effect of a new sports stadium was somewhere between 1.3 and 1.8 (although many academic economists were savagely critical of such claims) . Economist and political pundit Paul Krugman has been using a multiplier effect of 1.5 in his recent columns.
http://www.nytimes.com/2009/01/09/opinion/09krugman.htmlThe problem with the "multiplier" effect justification for public spending programs is that there is a large body of recent academic literature concluding that it is
much smaller than 1.5 and rarely if ever reaches even 1.0. According to Barro's calculations, the multiplier effect for public spending ranges from 0.8 for wartime military spending to "insignificantly different from zero" in the case of of peacetime governmental purchases:
I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports -- personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses -- there was a dampener, rather than a multiplier.
We can consider similarly three other U.S. wartime experiences -- World War I, the Korean War, and the Vietnam War -- although the magnitudes of the added defense expenditures were much smaller in comparison to GDP. Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 -- the same value as before. (These estimates were published last year in my book, "Macroeconomics, a Modern Approach.")
There are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases. For one thing, people would expect the added wartime outlays to be partly temporary (so that consumer demand would not fall a lot). Second, the use of the military draft in wartime has a direct, coercive effect on total employment. Finally, the U.S. economy was already growing rapidly after 1933 (aside from the 1938 recession), and it is probably unfair to ascribe all of the rapid GDP growth from 1941 to 1945 to the added military outlays. In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.
See,
online.wsj.com/article/SB123258618204604599.html. Barro argues that a much more plausible assumption for public spending is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP -- consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one.
This is not to suggest that public spending infrastructure improvements is not beneficial or even necessary for long-term economic growth. Much of this infrastructure is needed now, regardless of the current economy (for example, Seattle is in drastic need of long delayed transportation infrastructure improvements and the US is in dire need of new energy production facilities that are not dependent on fossil fuels). However, such spending is unlikely to generate the stimulus needed to stop the current economic tailspin.