Sunday, 22 July 2012

The multiplier is irrelevant.

The amount of employment created per million pounds spent varies with HOW the money is spent. For example, if the money is channelled towards groups of the population that save more than normal, relatively little employment is created. That is, the so called “multiplier” is low. And this leads some na├»ve folk to deduce that stimulus money should be channelled towards economic activities with as high a multiplier as possible.

The idea is invoked by the author of this “Touchstone” article and the authors of this recent IMF report on the UK. But then as Bill Mitchell has pointed out ad nausiam, the IMF gets just about everything wrong.

The basic flaw in the multiplier argument is that creating money with a view to spending it costs a monetarily sovereign country NOTHING. Money can be created at the press of a computer mouse.

So let’s assume there is a choice between employing people to perform economic activity A and activity B. Also suppose that the multiplier under A is poor because those concerned save a high proportion of the increased income that is caused by implementing A.

Also suppose that REAL OUTPUT per head is higher under A than B. Which should we go for: A or B?

The answer is A, because economics is all about maximising REAL GDP per head (within environmental constraints). The fact that those involved in A choose to store a large proportion of their increased income under their mattresses (to put it figuratively) is irrelevant. It does not cost anything to print more £20 notes for people to sleep on, if that’s what they want to do.

Weimar, Mugabwe, bla bla bla.

Of course a significant portion of the population, if not a majority, start chanting “Weimar” or “Mugabwe” as soon as they hear the phrase “create money” or similar.

They need to read David Hume’s essay “On Money” written over 250 years ago. As Hume correctly pointed out in relation to money supply increases, “If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated.” Quite right. And stuffing money under mattresses has exactly the same “non-effect”.


Another problem with skewing the economy towards SPECIFIC areas of economic activity, is that those areas are likely to run into skills shortages and capital equipment shortages before the rest of the economy reaches capacity. I.e. inflation is likely to rear its ugly head before full employment is reached.

Of course people can possibly be re-trained to deal with those skill shortages, but what’s the point? When the recession is over and the above “skewing” is unwound, those newly acquired skills become redundant and those concerned have to return to using the skills they had in the first place.


Another possible reason for multiplier differences as between different forms of economic activity (mentioned by the IMF report) derives from the different extent to which imports are sucked in. But that is not a reason to concentrate on non-import dependent activities: activities which as a result have a high multiplier. Reasons are as follows.

First, the policy is a form of “beggar my neighbour”: creating jobs in one country at the expense of another. That policy might be justified where JUST ONE country is in recession. But that is not the case: a significant proportion of countries worldwide are in recession. Thus if every country ignores the IMF’s daft “concentrate on non-import dependent sectors” idea, that WILL SUCK IN more imports to any given country than if that country were to ignore the IMF’s advice. But if every country does the same, then its swings and roundabouts: the deterioration in one country’s balance of trade as a result of ignoring the IMF will be nullified by GAINS TO its balance of trade deriving from the fact that other countries are adopting the same policy.

Second, unless market failure can be demonstrated, we can only assume that for any given country, market forces result in an amount of international trade relative to GDP that is about optimum. Moreover, that ratio is not going to change significantly as between recessionary and non-recessionary times (at least, certainly not if other countries are in recession at the same time).

Thus distorting the economy towards non-import dependent activities, as per IMF advice, just results in a misallocation of resources. That is, it reduces GDP and living standards.

And even if the above “international trade to GDP” ratio DOES change when a country is in recession, then again, unless market failure can be demonstrated, the assumption must be that the market has got the “international trade to GDP” ratio about right (recession or no recession).


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