# The Real Multiplier

In truth, the Keynesian multiplier is a mathematical fiction, as explained here, and government spending is in fact destructive of economic growth, as discussed here and in some of the posts listed at the end.

GRAPH UPDATED 12/01/13

The Keynesian multiplier is bogus, for reasons spelled out in “A Keynesian Fantasy Land.” By bogus, I do not mean that government spending (G) has no effect on gross domestic product (GDP). What I mean is that the effect of G on GDP is (1) overrated and (2) irrelevant.

The effect of G on GDP is overrated because, contrary to the assertions of quacks like Paul Krugman, an increase in G does not cause an increase in GDP. For example, Robert Barro writes:

For annual data that start in 1939 or earlier (and, thereby, include World War II), the defense-spending multiplier that applies at the average unemployment rate of 5.6% is in a range of 0.6-0.7. A multiplier less than one means that, overall, other components of GDP fell when defense spending rose.

My own analysis of post-WWII statistics (for 1947-2010) yields a multiplier for G of 0.8. [UPDATE: A more authoritative estimate is 0.5.] That is to say, every additional dollar of government spending has led to a 20-cent reduction in non-government spending. To put it another way, the real effect of additional government spending is the shrinkage of the private sector. (Which makes sense, when you stop to think about it.) Thus the irrelevance of the multiplier: What good is more government spending if it shrinks the private sector, where real products and services are produced?

It is quite true that private investment in business capital (buildings, equipment, technology, etc.) rises and falls with the business cycle. The elasticity of new investment with respect to private-sector GDP (GDP – G) during the period 1947-2010 was about 3.3; that is, every 1-percent change in private-sector GDP resulted in a 3.3-percent change (in the same direction) in new investment. (Kevin Hassett clearly discusses the causes and effects of these fluctuations in “Investment,” at the Library of Economics and Liberty.)

But no matter the level of investment, it yields positive returns in the aggregate and most of the time. That is the reason for positive, real interest rates on corporate debt, and for the rising real value of stock prices over the long run. The average rate of return on net capital investment (i.e., after depreciation) for 1947-2010 was about 10 percent. However, there was a marked downward trend until the early 1980s, followed by what seems to be a leveling off. The average since the “Reagan recovery” of the mid-1980s has hovered below 8 percent.

Source: Derived from BEA Table 4.1 Current-Cost Net Stock of Private Nonresidential Fixed Assets by Industry Group and Legal Form of Organization, Table 1.3.5. Gross Value Added by Sector, and Table 1.15. Price, Costs, and Profit Per Unit of Real Gross Value Added of Nonfinancial Domestic Corporate Business.

In sum, the real multiplier on government activity is markedly negative. Government activity has resulted in an ever-deepening Mega-Depression.