Bryan Caplan  

A Parallel Fallacy

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How would you respond to someone who said the following?

GDP by definition is consumption plus investment plus government spending - C+I+G. Therefore increasing government spending increases GDP.

The right answer, of course, is that higher G only increases GDP holding all else equal. It is quite possible that raising G by $100 B reduces C+I by $100 B. Net effect: zero, but GDP still equals C+I+G. The deeper lesson is that accounting identities can't resolve empirical questions.

Now note that this example exactly parallels NRO's argument that government borrowing can't crowd out private borrowing:

Will private borrowers be crowded out [by increased government deficits]? Impossible. The causation is “loans create deposits,” as taught on day one of every traditional money and banking class. The act of borrowing itself creates exactly that same amount of new liabilities (deposits). The process is “self funding” and circular, as a matter of accounting.

As a matter of accounting identities, loans create deposits. But this sheds no light on the substantive question of crowding out. Even if a $100 B deficit leads to $100 B fewer loans to private borrowers - full crowding out - the books still balance.

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COMMENTS (11 to date)
Eli writes:

FURTHERMORE, GDP = C+I+X+G only if government product equals government expenditure. Does it? Of course not! When the government hires a bureaucrat at $40k, they probably get only $30k of labor out of him. C+I+X+G only works if you assume that government is as affected by market forces as private industry, which of course is not the case.

Don writes:

Dude, you're missing NX.


Don writes:

(But your point is, of course, correct).

Bill Stepp writes:

Assuming a closed economy, the correct equation is:

Y = C + I - G

where C + I = private income and
G = government depredation.

We can also write it as

Y = C + S - T

where C + S = private production and
T = tax theft.

Just think of government as the New Orleans cops looting Wal-Mart, or as a former FEMA director taking a kick back from the Gov. of Louisiana to be on her side of the blowback.

But as Mises pointed out, the concept of national income runs roughshod over the fact that income is only acquired by individuals, not nations.
Even then, it's only earned by some but pilfered by others.

James writes:


Why would you subtract T from national income? I mean, I can see why it's a mistake to add it, but is subtraction really the appropriate thing to do? Consider an economy where no person or agency uses to coercion to finance its activities.

Y = C + I + NX
Now some of the people get tired of working and form a band of thieves. They take a portion of everyone else's income and spend it as they please.
Y = C + I + NX - T + G
Assuming that the band of thieves doesn't run a deficit, T = G, so we can substitute and get.
Y = C + I + NX - G + G
The two G terms cancel out, leaving
Y = C + I + NX

Bill Stepp writes:

Government depredation is a drain on the economy, so G should be subtracted. G isn't spent in response to consumer demand.

jaimito writes:

You guys must be just kidding, but leadership is very valuable and necessary for humans trying to doing anything. If you have a band of thieves, you need a ringleader, and his services are much more valuable than the services of ordinary team members. A good president is worth is weight in gold.

spencer writes:

To a certain extent the entire analysis is poor.

Remember, we do not directly measure output.
Rather, we measure consumption and adjust it for changes in trade and inventories to indirectly measure output.

It just says supply = demand, but we just look at demand and assume supply will be there.

Computer production can account for x% of output, as chemicals can account for y% and energy for
z%. but consumption is zero percent of output.
Output is really a function of investments, output per worker, productivity, the labor supply, etc. rather then the C+I+G identity.

Because we look at the world through this framework we get a lot of poor analysis.

This framework reflects the world at the end of the depression when national accounts were first measured and the big economic problem was thought to be a lack of consumption and massive idle capapcity. So we focused on demand or consumption as a way of solving the problem of idle capacity. But inadequate consumption and idle excess capacity is not the problem now.
So maybe we ought to change our analytical framework to focus on the supply side of the equation rather then the demand side.

James writes:


Once the politicians start spending, they become consumers using the money to satisfy their own preferences. Is being a consumer a function of how one finances one's consumption? Let me ask this differently: If I borrow some money to go shopping, should my expenditures be added to national income as C? I'd say yes, and so would 99% of other economists. Your mode of analysis seems to imply that no answer can be reached until you know whether I pay off the loan with honest income or stolen cash.

Bill Stepp writes:


What government spends is not market-driven. Rothbard called it waste consumption.

Tino writes:

The argument is nonsens, but they are right that the deficit is no problem. It is now less than 3% of GDP and shrinking. Certainly the supply of capital is large enough to make the costs in terms of higher intrest rate (the mechanism what would crown out investments) very small.

Debt is a good way to hold down spending, which is what should be the most important priorety.

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