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The Magic Pudding

By Steven Schwartz - posted Friday, 30 August 2013


Announcing the latest round of assistance to the motor car industry, Minister Kim Carr urged us to think of the handout as a "co-investment". According to Carr, "every dollar we put in ... generates about $20 for the economy". This is truly astonishing. Put your money in the bank and you are lucky to collect 3 cents in yearly interest, but hand a dollar over to Holden and it miraculously turns into $20.

Applying Carr's arithmetic, the $2 billion that Labor proposes to give Holden will generate a return of $40 billion (almost enough to pay for the National Broadband Network). With such a lucrative return, why think so small? Why not give Holden $10 billion and give the economy a $200 billion boost? Or, toss in $50 billion and go for a cool trillion?

Carr did not explain how this incredible "investment" works, but you can be certain that the money will not come from manufacturing cars. Holden is a zombie business, technically dead but still breathing because of regular injections of taxpayer funds. Giving Holden a handout is like putting bandaids on a corpse. Even Holden's managers admit that the company will never be profitable, justifying endless handouts by claiming that every country is doing it.

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If an investment in Holden cannot be expected to make any return at all, let alone the

turbocharged one predicted by Carr, then where is the money to come from? It is likely that the Minister is relying on some grotesquely exaggerated version of Keynesian macroeconomics, which prescribes public spending as a way to increase "aggregate demand" in times of recession. The idea is that the $2 billion given to Holden will eventually make its way into the pockets of the company's suppliers and workers. They, in turn, will invest it in new equipment or workshops or spend it on consumer goods, education and holidays. As the money ricochets around the economy confidence will grow and demand will rise. Unemployed workers and idle capital will be put to work to meet the increased demand. In this way, the initial $2 billion is multiplied, or at least that's the theory.

In practice, economists disagree about the size or even the existence of multiplier effects. Some claim that the multiplier effect of government spending is less than one. In other words, taking money out of the pockets of taxpayers and giving it to Holden actually depresses economic growth because the money could have been used more productively.

At the other end of the spectrum, economists using complex mathematical models have claimed to find evidence for multiplier effects of 1.5 or 2 but no one is currently claiming a multiplier of 20. If this number is accurate, Kim Carr has found a true magic pudding and he owes it to a troubled world to reveal the recipe.

But don't hold your breath; there is no magic pudding.

Even Keynes would not expect Holden's handout to generate economic growth because the economy is growing, unemployment is low and aggregate demand is relatively high. In such circumstances, redirecting money from productive uses to a moribund car manufacturer will either shrink the economy or increase inflation (or both). That is why Keynes demanded that governments run surpluses when the economy is healthy ("the boom, not the slump, is the right time for austerity at the Treasury"). Alas, this aspect of Keynes' thinking has never appealed to Labor governments, which routinely run budget deficits in booms and busts.

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Keynes despaired that his name had become attached to profligate government spending programs. He once left a meeting of government economists saying that he was the only non-Keynesian in the room.

It's time that our ministers stopped hiding behind a perverted version of Keynesianism. Keynes believed that markets work well most of the time. He understood that individuals pursuing their personal interests, guided by an unfettered price mechanism, make better investment choices than government ministers whose "investments" are political driven. And unlike hubristic politicians, Keynes did not believe that there are lucrative investment opportunities that are ignored by private investors but clearly visible to government ministers.

Keynes once described the ideal economist as a "mathematician, historian, statesman and philosopher." This is not a bad set of characteristics for a politician either. Alas, we seem to have wound up with just the opposite-mathematically illiterate, unable to learn from the past and whose only philosophy is power.

Steven Schwartz is a senior fellow at the Centre for Independent Studies

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About the Author

Steven Schwartz is a former vice-chancellor of Macquarie University.

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