Corporate & Securities Law

Kevin Murphy models the stimulus–and the results aren’t pretty

A great video from the University of Chicago here with comments from John Huizinga, Kevin Murphy and Robert Lucas. John Huizinga also wonders if we’re calculating the costs. Robert Lucas is skeptical.

But Kevin Murphy’s discussion is (not surprisingly) worth the price of admission (I only wish the video showed the slides). He puts some mathematical meat on the bones-answering my earlier question with a lot more variables than Krugman was able to muster.  His model itself raises a range of interesting and essential issues, seemingly glossed over by the stimulus fundamentalists (it’s their turn thusly to be tarred)–including (among others):

the relative inefficiency of government in allocating resources;

the conflict between stimulus and investment (between deploying underemployed resources and improving productivity);

the prospect of drawing otherwise productive resources into less-productive stimulus (Murphy: “You have to remember, even with 7% unemployment, 93% of the resources out there are being employed somewhere else. So when I try to draw things in, chances are I’m going to draw a lot of resources out of other activities.” (one might call this an error cost, but the Krugmans and DeLongs of the world don’t believe that governments can commit errors, unless led by Republicans, of course.));

the problem of diminished private savings (Ricardian equivalence);

the fact that even unemployed resources have value greater than zero (even unemployed people value their own time and reallocating otherwise-inefficiently employed resources to other sectors is a value);

deadweight cost of distortions from taxation.

At bottom, Murphy has this equation (I don’t know how to write Greek letters in WordPress, so bear with me):

f(1-L) > a+d

f = how much comes out of idle (as opposed to currently employed) resources

L (Lambda) = the value of idle resources (so 1-L is the gain from moving idle resources into production)

a = government inefficiency cost

d = deadweight loss

Iff the left-hand side is greater, the stimulus would be worthwhile

Murphy’s bottom line, given his parameters (f=.5, L=.5, a=positive, and d=.8):

Unless government is 55% more effective, more productive, than private output, it’s not looking good.

As Murphy notes, others like Christina Romer and Paul Krugman may believe that government is in fact much more efficient. I think the evidence is decidedly against them, but it is helpful to see what it comes down to. So what do you think?

Seems to me that Murphy has produced an enormously careful and valuable analysis of the sort that Krugman will dismiss as ideological, as he does with everyone who disagrees with him.  It is an embarrassment that Krugman (and not Murphy, et al.) has sway over the new US government and the intelligentsia (read: New York Times readers) that will enable the coming stimulus debacle.

Full post as published by Truth on the Market on January 20, 2009 (boomark / email).