Harvard economist N. Gregory Mankiw, former member of Bush’s Council of Economic Advisors and noted author of a popular introductory economics textbook, has a great article in the New York Times questioning the wisdom of government spending as a solution to our economic problems. One of the more important points he raises is how economic statistics will inevitably count new spending as a positive impact on the economy, even when the real effect may be negative:
If you hire your neighbor for $100 to dig a hole in your backyard and then fill it up, and he hires you to do the same in his yard, the government statisticians report that things are improving. The economy has created two jobs, and the G.D.P. rises by $200. But it is unlikely that, having wasted all that time digging and filling, either of you is better off. People don’t usually spend their money buying things they don’t want or need, so for private transactions, this kind of inefficient spending is not much of a problem. But the same cannot always be said of the government. If the stimulus package takes the form of bridges to nowhere, a result could be economic expansion as measured by standard statistics but little increase in economic well-being.
Mankiw also acknowledges, correctly, that studies show that government spending has a “multiplier effect“–one dollar injected into the economy generates more than one dollar of spending because it recirculates. But, the effects of tax cuts–putting money back in the hands of taxpayers–have an effect roughly twice the size of an increase in spending.