Archive for multiplier

The Failure of Keynesian Economics

Posted in Political Rant with tags , , , , on December 29, 2008 by lilburtonboy7489

Even with total financial collapse being possible, our government is looking to a failed economic theory for help. It’s called Keynesian economics. This theory has been shown by both logic and history that it is not a successful economic system. Keynesian economics is the theory that the government can stimulate economic growth by intervening in the private sector.

Many times, a theory will look good on paper, but ultimately fail in the real world. Keynesian economics is not one of those theories. It fails both in theory and in the real world, and I will show a couple of reasons why.

Keynes says GDP=C+I+G+NX So he assumes that if you increase increase any variable in the equation, the GDP will increase accordingly. This is what his entire theory is based on. However, he consistently forgets that simply moving the wealth around is not creating wealth, but rather just allocating it differently. I’ll show some examples of this fallacy.

Before I address these issue, I would like to point out each variable I will use and give it’s definition:

GDP- Gross Domestic Product

C- Consumption

I- Investment

G- Government Spending

NX- Net Exports (Exports-Imports)

T- Taxes

MPC- Marginal Propensity to Consume (How much is spent out of every dollar)

First, consider this: C= c+{MPC*(Y-T)}. So in order to increase G, you have to increase taxes. Increasing taxes adds value to the variable T. Increasing T means that C will decrease. That is unavoidable.

So the increase in G is offset by the decrease in C due to higher taxes.The GDP doesn’t expand, it is just proportioned differently. A decrease in T (Taxes) has more of an effect on the economy than increasing G (Government spending) Why? Because consumers will only consume what they demand. We decide what has value. If we decide that iPods are more important to us than a parking ramp, iPods have more value. That’s because only the consumers can choose what has value by demanding it.

So when G is increased, production may increase, but not necessarily production of something we demand. For example, if government spending is increased to pay for a parking ramp in the middle of a cornfield, is that good? No, because something was produced which has no value because it’s not in demand. So government spending takes from consumers (the only people that can give value to something), and spends it on things which may not have value.

Consider this: According to this logic, shouldn’t the government hire people to run around and destroy things? If that was done, the government could spend the money to repair these things. It’s an increase in G and also gives jobs to people. So shouldn’t Keynes want that?

Of course, the problem is that nothing was created with value. So it did not expand our wealth.

All kinds of porblems arise when employment becomes an objective rather than a result. Keynesian economics is in large part a theory dedicated to fight unemployment. Since this is the case, all Kenesians are opposed to all technological advancements that make us more productive and successful, right? Of course, not, that was be ridiculous. But it would be entirely consistent for Keynesians to hold that position.

Another thing to understand, is that an increase in C (Consumption) is not intrinsically good. This is especially true when NX (Net Exports) decreases when C is increased.

For example, if our nation imports 90% of its goods and services, our NX will be negative, subtracting from our GDP. So what happens if our C increases by 50%? The -NX will increase enormously. So when we have a deficit in NX, when our C increases, the increase in C is offset by the decrease in NX.

Keynes even came up with a concept knows as the “Multiplier”. The concept states that government spending is a more powerful tool of economic growth than letting the market consume. The equation for the multiplier is: 1/(1-MPC). Say that every consumer spends $0.75 out of every $1.00 they make. That makes the MPC=.75. So now apply it to the equation: 1/(1-.75)=4. This is called the “Multiplier effect”. Keynes says that if the government spends $1,000,000 to “stimulate” the economy, you multiply it by this multiplier. So in this case, as I showed above, the multiplier is 4. So you multiply the government spending by whatever your multipler is. So in this case, it would be 4 x $1,000,000=$4,000,000. And POOF! That money taken from taxpayers just quadrupled.

Of course, if you actually think this through, it’s a ridiculous concept. As I mentioned before, the only way value can be added to a product, is through consumer demand, which only the consumers can decide. So when the government consumes, it is taking our money, and spending it on things not in demand. Since worthless things are produced, there is no growth. The only change, is that the consumer who add value to products, have less spending power because the government has taken it and spent it elsewhere.

The entire concept of a multiplier is a joke, yet it is still the most widely accepted economic theory today.

So that’s my shallow critique of the problems associated with Keynesian economics and basically any type of government intervention in the economy. Our economic problems will continue of we don’t break away from this mindset that the government can fix the economy by interfering and printing money.

Advertisements