Growth and fiscal policy

The government has spent billions of our dollars and now the economy is doing (relatively) well. And as every good student of statistics knows, correlation proves causation. Based on this divine truth, the government has claimed credit, and many journalists and pseudo-economists have believed them.

But if expansionary fiscal policy leads to higher growth, then that rule should be true all around the world. So let’s have a look at the outcomes for a range of major economies.

The data for economic growth (% of GDP, estimate for 2009) and the size of the discretionary fiscal policy (% of GDP, combined 2008 & 2009) come from the IMF, except for the Australian growth estimate, which comes from the budget documents and is for 2009/10 (and may be revised up again shortly).

As the graph shows, there is almost no correlation between discretionary fiscal policy and economic growth (correlation coefficient = 0.0651, p-value 0.825, not statistically significant). Yes, Australia had lots of fiscal policy and relatively good growth (we are the dot above the 3.5) … but Japan, Russia, Spain and the US also had lots of fiscal policy with worse results.

Of the countries with relatively less fiscal policy (under 2%), there is also a range of outcomes. Brazil, Canada and France have generally done better than the above “Keynesian countries”. While the UK, Italy, Germany and Mexico have achieved growth rates about the same as the “Keynesian countries”.

The two outliers in this picture are China and India — one Keynesian and one not.

On it’s own, this does not prove anything. The performance of different economies is caused by many different factors which cannot be captured by looking at a simple correlation. But if people want to take a simple look at the “stimulus-growth” correlation, they should consider the whole world, and not just Australia. And the evidence from the whole world seems to back up what all good economists already know — that active fiscal policy doesn’t work.

UPDATE: Todd Craig pointed out that I had America in slightly the wrong place, and has provided an updated graph which includes the country names for each dot. Thanks Todd.


19 thoughts on “Growth and fiscal policy

  1. Listened to something related to this on the news as I was driving to work. Retail sales are down, as are inventories and jobs. The government’s going to have a hard time justifying themselves in a couple of months

  2. John – I think it would be useful to label your data points. You can get a free little add-on for excel called xy chart labeler which makes it very easy.

    Also, the Y axis is stimulus as a percentage of GDP, right?

  3. Steve — I think the government will be able to sell this quite easily. Most people don’t pay close attention to the details of the debate, and the government will try to sell the “we spent lots of money, and we did better than other countries” angle.

    Todd — I only just learnt how to turn an excel graph into a picture… so one step at a time. 🙂 As for your second question, the Y axis represents the “size of the discretionary fiscal policy (% of GDP, combined 2008 & 2009)”.

  4. Pingback: Keynesianism works, just not everywhere « Extreme Capitalists

  5. The Keynesian national accounting conception of economy in the first place is a comical fiction. No time, no capital structure, just watch computationally flawed nominal aggregates go up and down without proper context.

  6. John, I just double checked the data and it seems fine. From your chart it looks like you have the US at -3.8% growth for 2009. The IMF has that as the ‘advanced economy’ growth, the US is -2.6.

  7. John – could you please respond – I think confirming my fears would yield a very powerful argument against Keynesian policy, in that you would have shown it leads to inflation AND negative growth.

    Scary stuff.

  8. Todd — you were right and I was wrong. Thanks. The post has been updated.

    Mark — there is no statistically significant correlation between growth and fiscal policy, so a line of best fit is moot. But if you insist:

    Growth = -3.1253 + 0.2102*Stimulus (p-value 0.825)

    I don’t see how this leads to any conclusions regarding the philips curve, and I really don’t think any strong conclusion can be drawn from this data, except that the mainstream meme of “stimulus has worked” is not based on evidence.

  9. And yet…

    “Wayne Swan said the economy’s 0.6 per cent growth in the June quarter “defied economic gravity” and cited Treasury research showing the country would be in deep recession but for the federal government’s $42 billion stimulus package.”

    The Australian

  10. Treasury has sold it’s soul to the devil, and one day they will hang their heads in shame.

    Can’t really blame Swan for playing the politics of the situation. It’s just a shame that so many otherwise sensible people are falling for this crap.

    Yes, our economy is doing well. But how much could have come from the stimulus? About 60% was saved. Of the remaining 40%, at least half will come from international savings which means it’s perfectly crowded out. Of the remaining 15% that comes from domestic savings, some of that will create interest-rate crowding out. The remaining 5-10% of the fiscal policy may have worked by creating a temporary increase in money supply… but that will only speed up the point at which we have interest rate increases.

    For each dollar of stimulus we will have to pay interest, and also lose due to the efficiency cost of taxation. Total cost of a dollar stimulus will be about $1.50.

  11. I was having a think about this again earlier and realised that it may be a little unfair to measure fiscal policy against raw economic growth.

    There are a lot of variables in the economies of the nations in that chart. Japan, when booming, is lucky to grow by 4% a year, while growth of less than 10% is recession-like in China. These differences may be obscuring the effects of fiscal stimulus (something we should explore as good skeptics).

    I thought that a better idea would be to measure the difference in economic growth from the top of the boom to the bottom of the bust. That is, compare economic growth in 2007 to that in 2009. For example, if an economy grew by 5% in 2007 and shrunk by 5% in 2009, the difference would be (-)10%. Fiscal stimulus is intented to encourage spending, thus bolstering economic activity, thus boosting economic growth. Therefore, the peak-to-trough ‘distance’ should be smaller in those nations which have had substantial fiscal stimulus than those with little stimulus.

    Here is how it charts out:

    (Is it possible to embed images in these comments?)

    As you can see, there is no relationship whatsoever between fiscal stimulus and the peak-to-trough distance. There does appear to be a very weak correlation between stimulus spending and the peak-to-trough distance, but this is entirely a due to Russia.

    So again, government stimulus doesnt work.

  12. Maybe there’s a placebo effect- we get stimulated, think this is good for the country, and the whole country gets better! Here’s a new word- Placebonomics!

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