May 04, 2012
Most of the country is well aware of the fact that the United States is still suffering from the effects of the recession. The 8.2 percent unemployment rate is extraordinarily high. More importantly, the employment-to-population ratio, the percentage of people who hold jobs, is still almost 5 percentage points below its pre-recession level.
The fact that the country is still suffering from the recession is essential in assessing Andrew Bigg’s dismissal of the idea that public pensions can provide stimulus to the economy. Biggs is a prominent conservative economist who served in the Bush administration and is now at the American Enterprise Institute.
Biggs ridicules the idea that public pensions can provide stimulus, deriding it as the “broken window” fallacy in economics. This is the idea that economic growth could be increased by breaking windows, because we would then have to spend money to repair the windows.
In fact, because the economy is still suffering from recession — it has large amounts of unemployed workers and idle capacity — breaking windows would in fact generate demand and employment right now. The main problem facing the U.S. economy at the moment is a lack of demand and anything that creates demand would in fact increase growth and jobs.
This is exactly the point that Keynes argued back in the 30s. The government had to step in to fill the demand gap created by the private sector. In the 30s the demand gap was created by the collapse of the 20s stock bubble and the ensuing financial crisis. In the current downturn the demand gap was created by the collapse of the housing bubble and the ensuing financial crisis.
We can love the private sector to death, but it does not simply fill these gaps by itself. We can spend a decade or more worshipping job creators, but unless government steps in to generate demand, businesses will not increase investment and employment.
If Keynes seems old-fashioned, this argument is supported by recent research from the International Monetary Fund (IMF), an organization not known for its socialist leanings. The IMF found that government spending in a downturn did in fact boost the economy. The economy was especially likely to see benefits from government spending when the central bank was accommodating, as the Federal Reserve Board is now, with its quantitative easing programs and zero interest rate policy.
If we accept this research then the question is how much growth do we get per dollar of pension spending. Biggs is offended by the National Institute on Retirement Security’s (NIRS) claim that the economy gets $2.37 of additional output for each dollar of pension spending. This is due to the multiplier effect of spending. When retirees spend their pensions, this generates income for others (grocery stores, restaurants, etc.). The workers who get this money then re-spend much of it, creating another boost to the economy.
The $2.37 number may be somewhat high, but if we look at the Congressional Budget Office’s estimates of multipliers (Table 2), the top of the range for personal transfers (the category that would include pension benefits) is $2.10 per dollar of spending. That would suggest that NIRS was in the ballpark.
Of course we don’t expect to always be in a recession. When the economy is closer to full employment then Biggs would be right that public pension spending is pulling resources away from other uses in the same way that the hundreds of millions of dollars that governments pay to pension fund managers pulls money away from other uses. The question we need to ask in this context is whether public sector workers are overpaid. The evidence suggests otherwise, but that is another argument.
