Measuring the Effect of Infrastructure Spending on GDP

 

The Obama administration’s focus on infrastructure spending raises the natural question of the effect of government purchases on total GDP. Does government spending stimulate other categories of spending, especially consumer spending? Or does government spending displace other categories, so GDP rises by less than the amount the government spends?

Valerie Ramey has written a paper with the results of her recent work on the question and with a full bibliography of earlier work. Her answer is that consumption and other categories stay about the same when the government spends more. In other words, the increase in GDP is about equal to the increase in govenment spending. To focus on changes in government spending that are not themselves responding to conditions in the economy, she considers military spending. She finds that GDP rises by about the same amount as an increase in military spending.

The picture below shows GDP and government military spending during World War II, both adjusted for price changes, detrended, and rescaled to the level of the U.S. economy today.  If you think that the Obama administration is ambitious in spending a trillion dollars over several years on infrastructure projects, note that military spending maxed out at $7 trillion per year during the war, rescaled to the current size of the economy. During the expansion, GDP rose pretty much the same amount as did military spending. Consumption and other components of spending neither rose under the military stimulus nor fell because of displacement by military spending. The two forces offset one another. Notice, however, that when military spending fell after the victory, GDP did not fall nearly as much. Consumption and other components expanded rapidly to take up the resources freed from military activities and there was little sign of adverse effects from the lower military spending.

ww2

The second picture shows the same variables for the buildup at the beginning of the Korean war. The story is much the same-equal increases in military spending and GDP.

kor

Although military spending expanded in three other episodes-Viet Nam, the Reagan buildup, and post 9/11-none of these expansions was large enough to give much additional evidence on the response of GDP to increases in military spending.

We believe that the one-for-one rule derived from wartime increases in military spending would also apply to increases in infrastructure spending in a stimulus package. We should not count on any inducement of higher consumption from the infrastructure stimulus but we should also not worry that infrastructure spending might displace consumption and other categories of spending.

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14 Responses to Measuring the Effect of Infrastructure Spending on GDP

  1. [...] what are these multipliers? In their new blog, Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government [...]

  2. [...] Mark Thoma, Bob Hall and Susan Woodward argue against the multiplier effect of infrastructure spending by pointing out that GDP and [...]

  3. The attempt to deduce the fiscal multiplier for 2009 from the behavior of military spending and consumption in 1942-45 is mind-boggling. Has economics retreated from models and regression analysis to casual comments based on viewing of two variables plotted together?

    The behavior of consumption in 1942-45 was not freely chosen from a consumption function as would be relevant in 2009. Many nondurable goods were rationed, e.g., tires, gasoline, and key food items, and durable goods production was simply shut down by government orders. For instance, no cars were produced between early 1942 and early 1946.

    Thus the multiplier effect of higher government spending was shut off, as it will not be shut off in 2009. Thus the 1942-45 multiplier substantially understates the fiscal multiplier relevant for 2009.

  4. [...] Mark Thoma, Bob Hall and Susan Woodward argue against the multiplier effect of infrastructure spending by pointing out that GDP and [...]

  5. [...] We believe that the one-for-one rule derived from wartime increases in military spending would also apply to increases in infrastructure spending in a stimulus package. Vir. [...]

  6. [...] Measuring the Effect of Infrastructure Spending on GDP   The Obama administration’s focus on infrastructure spending raises the natural question of the effect of [...] [...]

  7. [...] Keynesian, throw money at the problem, solution. So what are these multipliers? In their new blog, Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government [...]

  8. [...] ce résultat est-il réellement corroboré ? Rien n’est moins sûr si l’on en croit cet article de Susan Woodward et Robert Hall sur leur tout nouveau blog. Ces deux économistes font référence à un article de Valerie [...]

  9. [...] what are these multipliers? In their new blog, Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government [...]

  10. [...] Measuring the Effect of Infrastructure Spending on GDP The Obama administration’s focus on infrastructure spending raises the natural question of the effect of [...] [...]

  11. [...] Measuring The Effect Of Infrastructure Spending On GDP – Via Financial Crisis & Recession [...]

  12. [...] Massive government spending on infrastructure might be good for the nation in general, but some evidence suggests it won’t be an economic stimulus. [...]

  13. [...] the government spends? What does research say about the left column in the table above? An earlier post addressed this [...]

  14. [...] stimulus over two years is nothing. During WWII the government spent at a rate that would be $7 trillion a year in today’s economy. __________________ [...]

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