No, extending unemployment benefits does have a cost

Every once in a while, I read something on the Purple Wisconsin site that brings me up short; that begs for a response. Recently, it was the following statement made by Kristin Hansen in a column making a "you can have your cake and eat it too" argument for extending unemployment benefits. She wrote:

Republicans love to complain that we can’t “afford” to pay unemployment benefits. But anyone who’s taken Econ 101 can tell you that cash paid out to the unemployed stimulates the economy by more than one and a half times its cost.

I am not an economist, but I went well past Economics 101.  I don't "know" that.

I'll concede, however, if someone took only Economics 101 and had a bad instructor, he or she might be "told" that.  While I understand Ms. Hansen has as little space in a blog post as I do, hers is a statement of a crude form of Keynesianism. But not all economists are Keynesians and even those who are have come to see the proposition as requiring a great deal more nuance. The reality is that what she says "everyone knows" is a highly controverted assertion based on cherry picking certain econometric models that are contradicted by other models.

The theory is this.  At least under certain economic conditions (a qualification that is often overlooked), moving money from one hand to another may result in greater aggregate demand and higher levels of economic activity. In this case, the hypothesis is that, if you give money to lower income people (the unemployed), they'll spend it, while the wealthier folks who you take it from would just put it in the bank. Because this activity reverberates through the economy, a dollar of goverment spending might be subject to a "multiplier" effect and generate more than a dollar in economic activity.

An immediate problem is that money in the bank is presumably used for investment that itself creates economic activity - although the Keynesian story is that, in times of recession, there will be no demand for invested funds. Another level of complexity arises if one one abandons the assumptions that people will react as if they are unaware that whatever is being done to "stimulate" the economy is only temporary and that those who are supposed to spend their newfound wealth or invest in response to such spending will not take into account that, at some point, taxes must be raised to pay for the stimulus. (The latter results in an odd argument about "animal spirits" that I have never been able to take seriously.)

The Keynesian view must establish that there is something wrong with the price system. It must explain why the goverment will know how to allocate resources more efficiently than the market.

Of course, this is a simplified version of the debate and there are others more qualified to elaborate on it than I am.  But what does the evidence show?

Ms. Hansen's observation is based on certain econometric studies (here's one oft-cited example) that claim to have "found" that the Keynesian story is true, The value of econometric models is itself vigorously disputed. Because we can't run really run controlled experiments in economics and the competing explanations for any particular economic state of affairs are multiple and intertwined, you have to make a great many assumptions about the relationship between the policy that you are evaluating and the result that you are "finding."

As a result, these studies tend to go every which way.  Some find that government spending, like extending unemployment benefits have a positive multiplier, while others find that they do not - even concluding that the "multiplier" is less than one. One of the real challenges for the Keynesian view is that there are no clear examples of it ever having worked as advertised in the real world. (The oft-cited example is World War II, but that really goes against the Keynesians.)

The Obama administration has engaged in an extended period of deficit spending - often by fiat - with little to show for it, although Keynesian proponents can always argue that whatever was done was not "enough" or, without it, the economy would have been "worse."

My own view is that, if one wants to make an argument for extending unemployment benefits (and I am not necessarily against it), it ought to be a humanitarian argument. That argument will have to acknowledge the risk that extending benefits may increase unemployment (by reducing the incentive to look for work), but argue that the benefit of helping those who simply can't find work is worth the cost.

But to argue that a positive multiplier effect is as certain as the Second Law of Thermodynamics is to confuse wishful thinking for proof.

Cross posted at Purple Wisconsin