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 Richmans' Trade and Taxes Blog

Why There Has Been No Keynesian Multiplier
Raymond Richman, 1/21/2010

The Keynesian multiplier posited that an increase (decrease) in investment (I) or in government purchases (G) will cause an increase (decrease) in national output equal to 1/(1-MPC) where MPC is the percent change in consumption that results from an increase in income.  To illustrate, an increase in domestic investment of $10 billion will increase income directly by $10 billion. If the MPC is 80 percent, the recipients will spend $8 billion on increased consumption, the recipients of the $8 billion will increase their consumption by $6.4 billion, which in turn will increase consumption by $ 5.12, and so on. The increase in I plus the successive increases in consumption amount to $50 billion. We believe there is no multiplier effect from governmnent-financed temporary employment. Mulltiplier effects can be expected only when enduring jobs are created increasing expected lifetime income, a conclusion that follows from Prof. Milton Friedman's hypothesis that consumption depends on expected lifetime income. Jobs that are expected to be temporary do not have multiplier effects.

The Bush and Obama administrations spent several hundred billions in the TARP program to stabilize the banking system in the belief that the banks in turn would make  loans to businesses. No demand for loans for investment in factories and equipment materialized and there was no increase in private investment and therefore no multiplier effects. Pres. Obama's so-called economic stimulus program spent a couple of hundred millions to stimulate public works which created no expected increase in lifetime income because of the temporary natrure of the jobs created and spent  hundreds of billions more on programs that simply supported existing state government budgets. No job creation there! It subsidized some school construction but created few jobs. Unemployment continued to rise throughout Pres. Obama’s first year which accords with the permanent income hypothesis.

We have no quarrel with the idea of the multiplier when it is applied to increases in productive investment. Our quarrel is with those who believe the multiplier applies to purchase of financial assets of financial institutions, to support of state and local government budgets, to subsidies like “klunkers”, to buying mortgages, to nationalizing businesses and insurance companies, to the gifts made to households by the Bush and Obama administrations, or to payments of unemployment compensation, etc., etc. None of the legislation that the administration has been pushing – health care, capping carbon emissions, man-made global warming grants and subsidies -- create enduring jobs.

There would be a multiplier only if there were increased private investment in enduring productive facilities. Unfortunately, private investment in manufacturing and construction in the United States has been nil. Investment in renewable resources subsidized by government is offset by the inefficiency of such enterprises which for all practical purposed produce nothing of value. The electricity they produce if valued at the cost of electricity produced by fossil fuels, hydro-electric, and nuclear plants would result in a negative return on investment which means they are equivalent to digging trenches and then re-filling them. The higher prices of electricity reduce the income of households and raise the costs of producing goods. Lowering demand and leading to a negative multiplier. 

Nothing that either administration has done has positive multiplier effects.

Here are some of the things we have been recommending that do have multiplier effects:

1. Stop the blood-letting of the enormous trade deficits. We recommend a cross-the-board uniform tariff to apply only to those countries with which we have been experiencing large chronic deficits. The purpose of trade is to exchange a basket of goods we value less for a basket of goods we value more. The rule should be balanced trade. Unilateral U.S. free trade is an abomination and has cost us millions of good industrial job s, caused wages to stagnate, and worsened the U.S. distribution of income.


2. Drill, drill, drill. We have billions of barrels of oil, unlimited natural gas, and successive administrations, on behalf of environmentalist extremists, have barred drilling on public lands, offshore in the Atlantic, Pacific, and the Arctic. Millions of jobs can be created drilling, distributing, and processing. Our dependence of foreign oil would diminish.


3. Repeal the Corporate Income Tax. Replace it with a value-added or other tax that can be rebated to     exporters under international rules. This will help level the playing field. Currently nearly all countries impose the value-added tax and rebate the tax to their exporters and impose the tax on our exports to them.


4. The current and proposed tax treatments of capital gains by both parties are full of economic mischief. They encourage disinvestment, i.e. the sale  and consumption of capital gains. We want to encourage investment, not disinvestment. The only treatment that capital gains require is the “roll-over”. When capital assets, including houses, are sold, the capital gain should not be taxed if it is reinvested. When the gains are consumed, they should be taxed as ordinary income.