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Thread: Comprehensive study of 145 countries:government spending depresses the private sector

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    Default Comprehensive study of 145 countries:government spending depresses the private sector

    The study http://www3.eeg.uminho.pt/economia/n..._WP_6_2009.pdf is the most comprehensive to date,covering data for 145 countries from 1960 to 2007. Its principal conclusion:
    "...an increase of government consumption by 1% of real GDP immediately reduces consumption (investment) by approximately 1.2% (0.6%).with the decline continuing for about four years when the cumulative decrease in consumption has reached approximately 1.9% (1.8%)."

    This effect does not depend on the phase of the business cycle.This finding contradicts the Keynesian model that promotes government spending on infrastucture and social welfare in recessions in order to exploit economic slack capacity and unemployment and to support consumer spending. If the study is correct,maybe Keynesian spending can only be guaranteed to work in economic depressions and ruinous financial panics as demonstrated in the 1930s Great Depression in the US,the UK and Germany. Hitler's economic programme in the 1930s has been described as military Keynesianism,while the US didn't fully emerge from the Depression until WWII's surge in military spending.

    An interesting question is suggested by the study: if increases in government consumption depress the private sector,doesn't that strongly imply that cuts in government spending would have the opposite effect and grow the private sector? Some research suggests that the effect of cuts could be moderately negative in the short run and beneficial after a few years. In my opinion,the higher the level of government spending relative to the GNP,the more beneficial the effect of the cuts: Economies with government spending around 60% of GNP such as Sweden in the 1980s and Ireland at present would benefit more from cuts than third world economies with parsimonious spending of 12 to 15% of GNP.

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    Politics.ie Member seabhcan's Avatar
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    Quote Originally Posted by patslatt View Post
    "...an increase of government consumption by 1% of real GDP immediately reduces consumption (investment) by approximately 1.2%
    So every 1% of government spending saves the private sector 1.2% spending. Does this not mean that public spending is 20% more cost effective than private spending?

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    Politics.ie Member TradCat's Avatar
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    Quote Originally Posted by seabhcan View Post
    So every 1% of government spending saves the private sector 1.2% spending. Does this not mean that public spending is 20% more cost effective than private spending?
    Was that a joke? I hope so because it's a good one.

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    There's no place for privateers in the provision of essential goods and services. This needs to be the domain of democratic enterprise. The privateers were given carte blanche to rule the world for the last 30 years or so, and they failed spectacularly. Its time for sanity and democracy is reassert thenselves.

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    Quote Originally Posted by patslatt View Post
    The study http://www3.eeg.uminho.pt/economia/n..._WP_6_2009.pdf is the most comprehensive to date,covering data for 145 countries from 1960 to 2007. Its principal conclusion:
    "...an increase of government consumption by 1% of real GDP immediately reduces consumption (investment) by approximately 1.2% (0.6%).with the decline continuing for about four years when the cumulative decrease in consumption has reached approximately 1.9% (1.8%)."

    This effect does not depend on the phase of the business cycle.This finding contradicts the Keynesian model that promotes government spending on infrastucture and social welfare in recessions in order to exploit economic slack capacity and unemployment and to support consumer spending. If the study is correct,maybe Keynesian spending can only be guaranteed to work in economic depressions and ruinous financial panics as demonstrated in the 1930s Great Depression in the US,the UK and Germany. Hitler's economic programme in the 1930s has been described as military Keynesianism,while the US didn't fully emerge from the Depression until WWII's surge in military spending.

    An interesting question is suggested by the study: if increases in government consumption depress the private sector,doesn't that strongly imply that cuts in government spending would have the opposite effect and grow the private sector? Some research suggests that the effect of cuts could be moderately negative in the short run and beneficial after a few years. In my opinion,the higher the level of government spending relative to the GNP,the more beneficial the effect of the cuts: Economies with government spending around 60% of GNP such as Sweden in the 1980s and Ireland at present would benefit more from cuts than third world economies with parsimonious spending of 12 to 15% of GNP.
    I think the study is too general to apply to our current situation - certainly all indicators would overwhelmingly suggest that deflationary budgets of the past 2 years served to dampen demand rather than the contrary.

    As regards your theory on effectiveness being dependent on Gov Spending to GDP ratio, it may have merit, but would again question it in the Irish context, as that ratio has gone up as a result of GDP going down rather than public sector spending soaring.

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    Quote Originally Posted by Conchubhairb View Post
    I think the study is too general to apply to our current situation - certainly all indicators would overwhelmingly suggest that deflationary budgets of the past 2 years served to dampen demand rather than the contrary.

    As regards your theory on effectiveness being dependent on Gov Spending to GDP ratio, it may have merit, but would again question it in the Irish context, as that ratio has gone up as a result of GDP going down rather than public sector spending soaring.
    "The differentiated effects of government consumption on private consumption
    and investment among geographical areas are extremely important and need to be
    further investigated. In particular, it would be interesting to assess to which extent the
    effect of government spending on consumption and investment depends on political and
    institutional variables (e.g. democracy, corruption, political stability) as well as macro
    economic variables (income, interest rates, degree of openness). We leave this
    challenging avenue for future research."

    More work needed here Pat.... especially on the effects of corruption and degree of openess.

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    Quote Originally Posted by Conchubhairb View Post
    I think the study is too general to apply to our current situation - certainly all indicators would overwhelmingly suggest that deflationary budgets of the past 2 years served to dampen demand rather than the contrary.

    As regards your theory on effectiveness being dependent on Gov Spending to GDP ratio, it may have merit, but would again question it in the Irish context, as that ratio has gone up as a result of GDP going down rather than public sector spending soaring.
    The deflationary budgets relied on a frenzy of tax increases and did not cut government spending which still managed to increase. Increasing taxes in a recession is the economic equivalent of kicking a man when he is down and helped turn recession into depression.

    The ratio of government spending to GNP rose sharply from 2002 onwards
    ( http://www.finance.gov.ie/documents/...10/Junemeb.pdf ) in response to electioneering and the political clamour for advanced welfare state services,services the government failed to deliver in many areas,especially in the dysfunctional health services. The ratio rose further as the economy entered a depression.
    Last edited by patslatt; 31st October 2010 at 06:24 PM.

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    Quote Originally Posted by patslatt View Post
    An interesting question is suggested by the study: if increases in government consumption depress the private sector,doesn't that strongly imply that cuts in government spending would have the opposite effect and grow the private sector?
    No it does not, and for a variety of reasons.
    "The war against drugs is unique in all conflict: we can win it, simply by ceasing to fight it."

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    Quote Originally Posted by rubensni View Post
    No it does not, and for a variety of reasons.
    Pray,tell,why? Give us the benefit of your wisdom!

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    Quote Originally Posted by patslatt View Post
    Pray,tell,why? Give us the benefit of your wisdom!
    You don't even need to read the whole paper Pat, just my little excerpt above.

    In it the authors themselves say that the effect of govt. spending on consumption and investment depends on "political and institutional variables (e.g. democracy, corruption, political stability) as well as macro economic variables (income, interest rates, degree of openness)."

    and

    "We leave this challenging avenue for future research."

    Your conclusion "if increases in government consumption depress the private sector,doesn't that strongly imply that cuts in government spending would have the opposite effect and grow the private sector?" is not justified.

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