Home > Economic policy, Economics - General > A lot or a little, part 2

A lot or a little, part 2

March 2nd, 2008

This CT post on Stiglitz and the cost of the Iraq war reminded me to get going on one I’ve had planned for some time, as a follow-up to this one where I pointed out that the $500 billion in aid given to Africa over the past fifty years or so is not, as is usually implied, a very large sum, but rather a pitifully small one, when considered in relation to the number of people involved, and the time over which the aggregate is taken.

What are the sums of money worth paying attention to in terms of economic magnitude. I’d say the relevant order of magnitude is around 1 per cent of national income[1], say from 0.5 per cent to 5 per cent. Smaller amounts are important if you’re directly concerned with the issue at hand, but are impossible detect amid the general background noise of fluctuations in income and expenditure. Anything larger than 5 per cent will force itself on our attention, whether we will it or not.

To get an idea of the amounts we’re talking about, US national income is currently about 12 trillion a year, so 1 per cent is $120 billion a year. A permanent flow of $120 billion a year can service around $6 trillion in debt at an interest rate of 4 per cent, so a permanent 1 per cent loss in income is equivalent to a reduction in wealth by $6 trillion.

For the world as a whole, income is around $50 trillion, so the corresponding figures are $500 billion and $25 trillion.

What kinds of policies and events fit into this scale?

* A typical “small war”, like Iraq or the French war in Algeria, big enough to be a central policy issue for the duration, but not to impinge on the day to day life of most people (in the US/France that is, not in the country where the war is being fought) . The direct costs of the Iraq war have been running at over 1 per cent of GDP, and costs (such as looking after wounded veterans) will continue at this level for many years after the war is over. So the Stiglitz estimate of $3 trillion is about the right order of magnitude, but will probably turn out to be on the conservative side

* A typical recession reduces GDP (the right measure in this case) by around 3 per cent relative to its trend value. In most macroeconomic models, this loss is made up over a few years in the recovery phase, but I doubt that this is correct. I believe that some of the income loss in a recession is permanent, or nearly so, and countries that experience a string of bad macroeconomic episodes (for example, New Zealand) tend to lag others (like Australia) for a long time afterwards

* The amount promised by rich countries in development aid is 0.7 per cent of their income, which is in the range being discussed here. The amount actually delivered by most of them (around 0.3 per cent) is not. The amount required to achieve the UN Millennium goals is a bit over 1 per cent of rich country income. To give everyone in the world an income of at least $2 a day would cost around 2 per cent of the income of the rich countries (assuming 2 billion poor people with an average income of $1/day, doubling this would cost around $700 billion a year).

* Chronic national budget problems like the long-term deficit in the US Social Security fund typically involve a gap between revenue and expenditure of 1-5 per cent of national income

* The losses from the current financial crisis seem certain to be at least $500 billion and maybe more than $1 trillion. Allocated over, say, five years, this is comparable to a modest recession

[1] People mostly refer to Gross Domestic Product, which is much the same magnitude, but not a useful concept except in measuring shortrun economic activity

  1. Ian Gould
    March 2nd, 2008 at 22:47 | #1

    Perhaps, John, in this context a more appropriate measure of the significance of aid would be aid as a percentage of African economic output.

  2. mugwump
    March 2nd, 2008 at 23:46 | #2

    the $50 billion in aid given to Africa over the past fifty years or so is not, as is usually implied, a very large sum, but rather a pitifully small one

    indeed it would be, except that aid to Africa in that time period was over 10 times greater. More like $500B than $50B. And what do they have to show for it? Only the left thinks it is a good idea to continue t line the pockets of corrupt dictators.

  3. jquiggin
    March 3rd, 2008 at 06:32 | #3

    I’ve reopened comments on the previous post on Africa, so if you want to discuss it, please do so there.

  4. March 3rd, 2008 at 06:54 | #4

    it is so much easier to buy a dictator than to spend an equal amount of money in ‘seed’ activities as the grameen bank does. since helping poor people is an idealogical dis-incentive to action for those americans who normally direct foreign policy, if not much money is spent, and that ineffective, there is no occasion for surprise.

    genuine altruism is seldom seen in individuals, and should never be seen in nations, who always have plenty of worthy causes within their borders. foreign aid always expects a return, often crass, sometimes brutal. if foreign aid is to be an instrument of peace and human development, the numbers are much less important than the methods, and the methods are dependent on the motivation.

    it always comes down to democracy. without the ‘d-word’, political activity, even gift-giving, will be a cynical exercise in power enhancement by the elite.

  5. jquiggin
    March 3rd, 2008 at 07:15 | #5

    To repeat, comments on the previous post should be placed there. Anything further placed here will be deleted.

  6. Socrates
    March 3rd, 2008 at 16:15 | #6

    It seems to me that in this context the really big ticket items in most western economies (including Australia) are government spending on health and private spending on housing. Both are unavoidable, but both can be greatly influenced by policy. Get policy wrong in either of those areas and you really will waste a lot of money.

    The US spends more on health (public plus private) than any other OECD country – about 13% of GDP I understand. By comparison Germany and Switzerland deliver excellent comprehensive public health systems for 10% of GDP. Despite the US expense 40 million citizens have no health insurance. Hillary Clinton is right – this is their single biggest economic problem. Even a large powerful economy cannot afford that level of waste forever.

    Housing is another potential area of waste. I do not suggest that we should consider housing in purely economic terms, because obviously better housing is a private good that people value. But again, some countries deliver good quality outcomes cheaper than others. I often think the huge transaction costs in housing here – agents, government fees, huge numbers of renters paying agents because tehy can’t afford to buy – is just a waste. There is no “service” delivered – they are purely costs of an allocative system that is arguably not efficient.

    As an aside, I came to this position while working in transport in Canberra. At the time the entire federal transport budget was less than $2 billion per annum. One year the cost overruns in a single defence budget (Collins class submarines) exceeded the transport budget. Health cost increases in turn exceeded the entire deefence capital budget.

    Finaly, when seen in this context, global warming is an affordable problem to solve. If we simply mandated standards that would fix it, the cost woudl be bearable for most, emmision trading or not.

  7. melanie
    March 3rd, 2008 at 20:48 | #7

    a permanent 1 per cent loss in income

    It is a loss only to the extent that the debt service payments go to, say, a European rather than an American bank (which may in turn assist the former in servicing debt to the latter & so on) . It seems more like a taxpayer subsidy to the private sector. Just as much of the ‘cost’ of the Iraq war is ‘revenue’ for Halliburton et al. No?

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