Ivan Seeking said:
There is a popular claim that the New Deal didn't end the Great Depression; that it only ended because of WWII.
1). How did WWII help to end the depression?
2). Generally speaking, do wars create wealth, and if so, how?
If your answer to number 1 is government "government spending", then how is this different from any spending package that creates short-term or long-term jobs?
Ivan Seeking said:
...The follow-up question was, "how is this different from any spending program?" I can see how wars spur growth through spending, but it also seems apparent that any spending program that invests in US industry could have the same result. If so, then how can the Republicans cite the war as the solution to the Depression but oppose the spending program? History suggests that we should spend much more in order to get out of this crisis - a level of spending on par with WWII, but aimed at growth industries and jobs creation.
I'd address these questions by changing the premises:
1. All spending is not equal, in either its effectiveness, or under the economic conditions under which it is done.
2. The economic effects of both the New Deal and WWII can not reduced down to just spending, thus its hard to equate the two in that way.
3. The classic definition of wealth
creation (not just sloshing it about) comes from Adam Smith as productivity increases brought about through the division of labor and specialization.
4. WWII did not necessarily cure the depression. There's scholarly debate on the topic. What 'Republicans' say it did?
Here's a quick textbook, macro 101, rehash of the analysis on the raising of economic output through government spending: the government spends $X. The person receiving $X will in turn spend some part of it and save part of it, in some ratio b. The next person down the line does the same, and so on, yielding a geometric series:
\sum_{k=0}^\infty b^k = \frac{1}{1-b},
The ratio b is the marginal propensity to consume (MPC). So if the MPC is 2/3, then the multiplier for the spending is 3.
The complete textbook 101 equation includes tax rate and import effects. Borrowed from wiki: \frac{1}{1 - b_C(1 - b_T) + b_M}
where:
b_C=propensity to consume,
b_T=tax rate,
b_M=propensity to import
This is a simple version of the standard Keynesian Multiplier.
The multiplier's reliance on the MPC immediately highlights why all spending is not the same. High MPC's come about when people have long term confidence in their income. Thus a good solid construction job, say building roads, tends to lead to a better MPC (go buy that house, car) than a simple transfer payment in the form of a short term unemployment benefit (hunker down) or Pell grant. These transfer payments may be desirable for other reasons (safety net), but they're not as an effective stimulus as a job. Furthermore, for the series to hold, at least the first few transfers need to be effective and not make-work or waste. For example, Japan has for years been trying to spend their way out of slow growth. One result of the quick spending was a boondoggle airport that is all but abandoned. In that case, after the construction was complete, the multiplier effect was broken in part because there were no follow on operational jobs at the airport.
Other problems with Keynesian multiplier theory are generally called 'Crowding Out' problems can in theory reduce the multiplier to zero. They also illustrate that even if we assume government spending is the right kind to be effective, it certainly has to be done under the right conditions. The derivation above is based on the IS/LM model Y = C(Y-T) + I(r) +G, (Y=output or GDP, C=consumption, T=taxes, I=investment, G=govt. spending, r=interest rates). Now that $X of increased G has to come from somewhere, and this gets to Russ's comment "It is simple math that running up the debt sucks money out of the gdp." Yes and no. To achieve stimulus the government wants to get the new G from borrowing, not taxes. The naive growth/spending analysis above assumes that investment elsewhere in the economy is
unchanged. In a recession, investment is down because demand is down so there is idle money laying around, or
excess liquidity. As long as that holds, the government should be able to borrow money without 'crowding out' the rest of the investment market and driving up rates. But of course it does not hold forever. Demand goes back up, in this case probably starting late '09. This is why stimulative spending, it it works at all, certainly doesn't work in a full demand economy. This is why we can't just spend ourselves into affluence, and this is why a large part of the current stimulus bill won't stimulate as it is not 'shovel ready' (CBO says ~2/3 spending 2010 and after) - it can not be done fast enough to catch this down cycle.
So does defense spending create wealth? In the short term it looks like it creates high MPC jobs, so somebody like Martin Feldstein has
http://online.wsj.com/article/SB123008280526532053.html"
