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Wednesday, April 08, 2009

Public Goods and Stimulus Packages

Two from Richard Green. First:

Adam Smith on Roads, by Richard Green: From Chapter 11 of the Wealth of Nations:

Good roads, canals, and navigable rivers, by diminishing the expense of carriage, put the remote parts of the country more nearly upon a level with those in the neighbourhood of the town. They are upon that account the greatest of all improvements. They encourage the cultivation of the remote, which must always be the most extensive circle of the country. They are advantageous to the town, by breaking down the monopoly of the country in its neighbourhood. They are advantageous even to that part of the country. Though they introduce some rival commodities into the old market, they open many new markets to its produce. Monopoly, besides, is a great enemy to good management, which can never be universally established but in consequence of that free and universal competition which forces everybody to have recourse to it for the sake of self-defence. It is not more than fifty years ago that some of the counties in the neighbourhood of London petitioned the Parliament against the extension of the turnpike roads into the remoter counties. Those remoter counties, they pretended, from the cheapness of labour, would be able to sell their grass and corn cheaper in the London market than themselves, and would thereby reduce their rents, and ruin their cultivation. Their rents, however, have risen, and their cultivation has been improved since that time.

Second, in response to Robert Lucas:

Two Questions about Macroeconomics, by Richard Green: I am not a macroeconomist. One of the reasons for this, I suppose, is that I was taught a lot of rational expectations overlapping generations stuff in graduate school and while I found it elegant, I did not believe it. The reason I didn't believe it is because the models are rejected by data: for instance, when households get short term changes in income, they seem to change their consumption behavior somewhat.

Nevertheless, there are ... macro issues that puzzle me. ...Ricardian equivalence types seem to have an underlying assumption that government can't invest in positive NPV opportunities. For instance, Robert Lucas argues that if the government borrows $100 million to build a bridge, household will know they have a future tax liability of $100 million, reduce their spending accordingly, and therefore offset the stimulative impact of the bridge.

But what if the cost to borrow for the bridge is 3 percent and the bridge's IRR is 5%? Then doesn't the bridge stimulate spending for the simple reason that it is a good investment? The federal government has made, it seems to me, some very good investments. Hoover Dam is one. Rural electrification is another. The interstate highway system. The Golden Gate Bridge. The New York City subway system. I could continue...

I do worry about bridges to nowhere. But many macroeconomists seem to believe in the hearts that public goods don't exist, and that there is nothing government can do better than the private sector. I think it is here that macro takes its cues more from religion than science.

[See also: Tax Cuts, Government Spending, Public Goods, and the Stimulus Package and Lucas: Monetary Policy Can Still be Effective.]

    Posted by on Wednesday, April 8, 2009 at 01:10 PM in Economics, Fiscal Policy, Market Failure | Permalink  TrackBack (0)  Comments (52)

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