How can the Tea Party have the economics right when even some in the business community seem to be displeased with how the Tea Party dealt with the debt ceiling and how it tarnished the Republican Party?
Well, here’s the figure that makes the Tea Party’s point. The figure represents the dynamic economic effect of reducing federal expenditures.
Republican Party: Why the Tea Party has its economics right
The rest of this article explains why the Tea Party has its economics right, which is: reducing the costs of government, by reducing federal expenditures, has a positive economic effect.
Here are the details of why the branch of the Republican Party known as the Tea Party has its economics right.
First some brief background on economic multipliers.
An economic multiplier refers to the idea that industries are connected with each other.
For instance, if the federal government spends $1 on roads, that $1 ends up in the hands of businesses supplying gravel and other products to build and maintain roads. Those businesses, in turn, spend their money on employees, who then in turn spend money on groceries, airline tickets, and a bunch of other stuff. Suppose, just for illustration purposes, that the initial $1 in spending by the federal government increases overall national gross domestic product (GDP) by $1.10. In multiplier terms, the federal spending had a multiplying effect of 1.1.
Is a 1.1 multiplier good?
A multiplier above 1 indicates that spending, whether it be government or private sector spending, increases final demand above the initial spending amount. Any multiplier above 1 is worth it when it comes to government spending, at least in the short term.
A multiplier less than 1 but greater than 0 indicates that spending, usually by governmental entities, increases final demand by some amount less than the initial spending increase. A multiplier less than 1 is not worth it when it comes to government spending because more than $1 has to be paid back some time in the future.
The last possible value an economic multiplier can take is less than 0. In this case, government spending reduces overall economic activity.
Where do the Tea Party, Republicans, and Democrats fall on this spectrum when it comes to government spending?
Democrats certain believe that their social programs have some grand economic multiplier greater than, perhaps even enough to cover the interest cost on the government debt they like to issue to pay for spending today.
Republicans, on the other hand, generally fall in the less than 1 but greater than 0 crowd. Essentially, the economic multiplier is not worth it, but not harmful either. So called “business Republicans” likely fall into this category.
Where is the Tea Party? As a general guess, elected officials with a Tea Party bent see the government spending as barely positive to slightly negative. In essence, government spending generally isn’t worth it, and may make things worse over time.
Republican Party: What does the data show?
Well, not surprisingly, the academic studies are mixed, largely dependent upon what the researcher wants to find. Perhaps the world’s most renowned researcher on economic multipliers – Robert Barro of Harvard University – puts the federal government spending multiplier at around 0.4 to 0.8, meaning increased federal spending is, over time, a gigantic waste of money.
With this background in mind, here’s what the raw data show. Not surprisingly, the government spending multiplier is very low, between -0.04 and 0.24 for the years covered.
Why don’t the academic studies find these results? Well, some academic studies do, while others attempt to model things while controlling for the endogeneity of federal spending (meaning federal spending always goes up when output goes down, i.e. government spends a lot during a recession) or other factors.
This might be one reason why the Tea Party is highly skeptical of academic economists. Academic economists can take seemingly simple raw results like those above and manipulate things in such a way that the raw results are somehow wrong.
To make Tea Party members’ point simpler, here’s the results of a dynamic economic modeling system (those that do economic modeling can probably guess the source) on government spending.
Again, and probably unsurprising, the model show an initial increase in economic activity when government spending goes up (but less than 1), but then weakens and eventually causes economic activity to go negative as the economy becomes less productive, more bureaucratic, and less innovative.
Republican Party: Tea Party is right
Overall, the raw data and the dynamic modeling results confirm what everyone already knows but can’t politically say: the Tea Party knows what it’s talking about. The Tea Party has it right when it comes to economics, regardless how much certain business owners want to believe otherwise.
What the Tea Party has problems with is the politics of getting things done within the confines of governing systems that pander to the popular vote.