President elect Obama and his economic advisors have dramatically raised the size of the stimulus package they think we need. As Greg Mankiw points out, the size of the stimulus relative to the number of jobs it will allegedly create makes it expensive medicine:
Dividing one number by the other, that works out to $280,000 per job. What is going on here? Logically, it must be one of three possibilities:
1. The fiscal stimulus is going to be much smaller than is being reported.
2. The new administration is setting a low bar for itself when it comes to job creation.
3. The Obama team believes in very small fiscal policy multipliers.
Facing an increasingly ominous economic outlook, President-elect Barack Obama and other Democrats are rapidly ratcheting up plans for a massive fiscal stimulus program that could total as much as $700 billion over the next two years….Obama has set a goal of creating or preserving 2.5 million jobs by 2011.
Let me amplify the last point with a rough back-of-the-envelope calculation. The average weekly earnings of production and nonsupervisory workers is about $600, or about $60,000 over a two-year period. Granted, labor income is only about two-thirds of national income, and we have to add a few supervisors into the mix. So let’s say each job created means $100,000 of extra national income. If we are generating $100,000 of income with $280,000 of government spending, the multiplier is only 100/280, or 0.36. By contrast, traditional Keynesian models suggest a multiplier closer to 2.0.
If this is financed with deficit spending (and there is apparently no other way since we know other parts of the budget will not be cut) I suspect the Obama numbers are too optimistic. I could be wrong but I don’t think the traditional Keynesian model considers the effects of fiscal stimulus in a country as deeply in debt as the US. As our debt has risen the effect of each new dollar of debt on GDP has fallen. During the ’00s, it took almost $5 in new debt for each $1 in GDP. If that ratio holds true, the $700 billion new spending will increase national income roughly $140 billion. Using Mankiw’s example of $100,000 in national income for each job created works out to 1.4 million new jobs. In other words, a drop in the bucket. This stimulus will not work and the new administration will have to try again. Unfortunately, they will have increased our debt futher and so the next stimulus will cost even more to produce each new job.
When one finds oneself in a hole, stop digging.