Zandinomics

Zandi is worried that Republican plans to cut $61 billion in government spending this year — 1.7 percent of this year’s federal spending, 3.6 percent of this year’s deficit — will result in the loss of 700,000 jobs, and reduce economic growth by half a percentage point. This makes him a favorite among those who do not wish to see federal spending reduced.

But before we get too excited, let’s put Zandinomics in a bit of perspective.

First, we should dispose of the notion that Zandi is some sort of conservative Republican by virtue of his work for John McCain’s presidential campaign. It is true that Zandi was one of a number of economists from across the political spectrum whom McCain’s presidential team consulted for analysis of economic and business events, but he was never involved in formulating policy for the McCain campaign. In fact, Zandi is a registered Democrat, one who holds decidedly liberal political and economic views.

Second, Zandi’s record of forecasting is not unblemished. For example, in 2008 he was bullish about prospects for a recovery in the housing market. And he was one of the chief advocates of Obama’s stimulus plan, promising that it would create millions of jobs.

Zandi’s current prominence is based on an economic simulation he developed, allowing him to plug in government policies and report quotably precise estimates of how those policies will impact economic growth and job creation. But Zandi relies on an old-fashioned Keynesian economic model under which government spending creates a large “multiplier effect” that inevitably leads to growth.

Under this model, if government spends $1 billion to build a new bridge, the money doesn’t just disappear; it is used to pay wages to the bridge builders, buy steel, and so on. The bridge builders and steel suppliers in turn spend their income, raising consumption and creating demand as the money cycles through the economy.

If the multiplier equals one, then each unit increase in government purchasing leads to a unit increase in GDP, and government spending is essentially free. The government can build a bridge or invest in “green energy” without reducing anyone else’s consumption or investment: It’s a free lunch.

But Zandi goes even further. In his model, the multiplier is greater than one. This means that when government builds that bridge, not only does the bridge not really cost us anything, but building it generates additional resources that we can use to stimulate private consumption and investment: The free lunch includes a free dessert. In fact, the logic of Zandi’s model holds that government spending is such a good deal that it doesn’t matter if we needed the bridge in the first place; we should keep building it, tearing it down, and building it again, to multiply the money we are spending. From Zandi’s point of view, former Alaska senator Ted Stevens’s infamous “bridge to nowhere” wasn’t pork — it was a brilliant investment, and we should have built ten of them, or a hundred.

Of course, Zandi’s premise is simply a restatement of the ancient “broken-window fallacy,” an economic error refuted by the economist Frédéric Bastiat in 1850. In Bastiat’s parable, a shopkeeper’s careless son breaks a pane of glass in his father’s store. According to the economic theory popular at the time, that was actually a good thing, because it meant that the shopkeeper would have to pay the glazier to repair the window. The glazier then would use his new income to buy a pair of shoes, and the shoemaker would spend the money, etc. The cycle continues, and the economy is stimulated. As Bastiat notes, “You come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it.”

But as Bastiat pointed out, that leaves out an important calculation: what the shopkeeper would have done with the money had he not been obliged to buy a new window. “It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another,” Bastiat wrote. “It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.” The accident only means that the shopkeeper has spent six francs to bring himself back to the economic state he was in before the window was broken; he is no richer for it, but six francs poorer.

Zandi ignores the way in which government spending, taxes, and borrowing squeeze out private consumption and investment — what we might have done with the money had it not been taken by the government to build bridges to nowhere. And he ignores the need for economies to create new wealth rather than to simply redistribute existing wealth.

Winston Churchill once noted, “However beautiful the plan, one should occasionally look at the results.” However elegant Zandi’s model, we have not managed to spend our way to prosperity. On the other hand, we have managed to accumulate enormous debts that threaten to bankrupt our children.

Zandi is wrong — spending is not our friend. It’s time to cut.