Ontario’s Keynesian Stimulus: Another Case of Failed Econometrics

LvMIC:

On the heels of U.S. President Barack Obama’s newly proposed, $1.33 trillion adding budget, Terence Corcoran takes Ontario’s efforts in government stimulus to school in his latest Financial Post column:

The province’s massive deficit spending, announced in 2009, would be creating hundreds of thousands of jobs and adding to the provincial growth rate. According to the Conference Board’s 2010 report — commissioned by the Ontario government to document the impact of its multi-billion dollar Keynesian stimulus effort — the deficit spending on infrastructure would also boost productivity, offset the recession, and set the stage for recovery.

Two years later, the Conference Board returned to the scene of the crime to report that Ontario is in rough fiscal shape, growth isn’t happening, spending will have to be cut, taxes raised and the province needs “transformative changes.” Missing from the Conference Board report was any acknowledgement that Ontario might be sinking under the weight of the stimulus gold star the board had awarded the province.

The same tired narrative once again repeats itself: politicians looking to save the world are told by economists still mystified by John Keynes’ General Theory that they must do what they do best and spend squandered money on special interests.  Savers are thrown to the wind and precious capital is spent on highways to nowhere as all the resources Leviathan distributes remain unused by the private and more prudent sector.  And like Obama’s stimulus package of 2009, the projected effects of massive government expenditures predictably fell short of meeting expectations.

That the forecasters and theorists turned out to be dead wrong comes back to haunt no one. In Ontario’s 2009 budget, the province predicted that its total debt would rise gently to just over 30% of the province’s gross domestic product before beginning a decline. GDP growth, according to a consensus of Keynesian private-sector economic modellers, would rise to 3.3%, in part under the stimulus helium provided by the deficits. As it turned out, within two years forecasts had turned sour. The new debt-to-GDP ratio looked set to top 40% (see graph above). What happened is (a) the deficits kept growing and (b) the forecast growth rates began to look a little rosy. Rates of 3% and 3.5% were expected, presumably the result of all the infrastructure spending and productivity gains. Now, however, the forecast average growth rate is said to be unlikely to exceed 2%.

Like Gary North says, “Governments lie. They cheat. They steal.”  If the political class is going to buy more pork, they better make it, or find someone to make it, sound worthwhile.  But the evidence is clear even in Ontario as the promised short-term boost in the deficit is not a one off event:



In his important Nobel acceptance speech “The Pretense of Knowledge,” Fredriech Hayek laid out exactly why such precise economic prediction models are bound to fail (my emphasis added):

But when we are asked for quantitative evidence for the particular structure of prices and wages that would be required in order to assure a smooth continuous sale of the products and services offered, we must admit that we have no such information. We know, in other words, the general conditions in which what we call, somewhat misleadingly, an equilibrium will establish itself: but we never know what the particular prices or wages are which would exist if the market were to bring about such an equilibrium. We can merely say what the conditions are in which we can expect the market to establish prices and wages at which demand will equal supply. But we can never produce statistical information which would show how much the prevailing prices and wages deviate from those which would secure a continuous sale of the current supply of labour. Though this account of the causes of unemployment is an empirical theory, in the sense that it might be proved false, e.g. if, with a constant money supply, a general increase of wages did not lead to unemployment, it is certainly not the kind of theory which we could use to obtain specific numerical predictions concerning the rates of wages, or the distribution of labour, to be expected.

Why should we, however, in economics, have to plead ignorance of the sort of facts on which, in the case of a physical theory, a scientist would certainly be expected to give precise information? It is probably not surprising that those impressed by the example of the physical sciences should find this position very unsatisfactory and should insist on the standards of proof which they find there. The reason for this state of affairs is the fact, to which I have already briefly referred, that the social sciences, like much of biology but unlike most fields of the physical sciences, have to deal with structures of essential complexity, i.e. with structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables. Competition, for instance, is a process which will produce certain results only if it proceeds among a fairly large number of acting persons.

At best, stimulus spending provides a short term boost for favored interests.  At worst, it devotes resources toward unprofitable and inefficient industries which yield no long term wealth enhancement at a time of needed market correction.  Stimulus spending is a mere excuse for the wealth distributors to try and buy more votes in the midst of a crisis.  Meanwhile, economists looking to find themselves in the good graces of the state not only promote stimulus packages but fall back on the tired excuse of “it wasn’t big enough” when the results fall short.

As Henry Hazlitt noted, “there is no more persistent and influential faith in the world today than the faith in government spending.”  As long as the mythical free lunch continues to exist in the writings of the  mainstream commentariat, counter cyclical stimulus spending will find an appetite by those wishing to oblige the money handlers.