Still don\’t get this to be honest

Changes to tax and spending affect the economy. If a pound of extra spending delivers a pound of extra growth, that means the multiplier is 1; if it delivers 50p of extra growth then the multiplier is 0.5. The same ratios apply in reverse when governments are imposing austerity programmes.

The thing is, we actually define £1 of government spending as £1 of GDP.

It\’s right there in the national accounts. Government contribution to GDP is simply and exactly the amount that government spends.

Everything else is determined by the value at market prices of the production from spending. But not government. That\’s defined as the amount spent.

And for years I\’ve felt that there\’s just not something quite right about that. It seems, in a way that I\’m not really able to put my finger on properly, to be wrong.

Does the marginal £ of government spending actually produce a £ of value? I\’m absolutely delighted to agree that the first £ produces much more than a £ in value. Courts, police, legal system, public health measures (real ones, vaccines and sewers, not anti-smoking jeremiads), sure, these add more than £ for £. But the marginal £ at 40, 50% of GDP? Deeply unconvinced.

Questioning this leads to some odd places. The balanced budget multiplier for example. Govt taxes and spends and this boosts the economy. Yet we know that the deadweight cost of marginal tax is somewhere in the 30-50% range. Thus to really, actually, add value the value of what we get for that spending has to be £1.60 to £2, for each £ spent. And as I say, I\’m deeply unconvinced that it\’s even worth £ for £ at the current margin. But we do define it as such.

As I say, I\’m not really sure quite how to walk through all of this properly. At least part of it is because I know so little macro. But I am sure that we\’ve got something wrong going on in here just because we define government spending as having the value of exactly that government spending. Something which I\’m adamant just ain\’t so.

6 thoughts on “Still don\’t get this to be honest”

  1. Tim: I’m not sure what your point is. There are various ways to calculate GDP, which ought to come to the same thing. The Expenditure approach adds Private Consumption, Government Spending, Investment, and Net Exports. So far as I know, the calculations of Private Consumption and Government Spending are exactly equivalent.

    For example, if I employ a nanny, her gross salary counts in my expenditure, and anything she spends it on counts as well. If the government provides childcare, its gross salary costs count in government spending, and anything its employees spend their money on counts too.

  2. The calculation for consumption subtracts taxes, and the whole function for GDP then adds government spending, so if T=G, you could say that the GDP figures in the expenditure approach equals all market value of private expenditure, but stealthily replaces a portion of it with government spending…

  3. It’s purely nominal, Tim. “Value” doesn’t enter into it. Increasing government spending increases NOMINAL GDP. The trade-off between increased real GDP and increased prices then depends on the slope of the Aggregate Supply curve. If the AS curve is nearly flat, increasing nominal GDP will increase real GDP. If the AS curve is steep, the effect will be on prices.

  4. PaulB: you are quite right, the expenditure approach does not do that, but calculates the value of govt expenditure at cost.

  5. In a nutshell, GDP is measured by price not value. So New Labour increased GDP by increasing public sector salaries.

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