Monday, December 8, 2008

Keynesian Irrelevance II: Multiplier (or Investment)

It is important to recognise the irrelevance of Keynes in today's world because, if we do not, then we will end with with impotent policies of a Keynesian nature. Let me elaborate.

To any slight economic downturn or depression, all of us have "pump-priming" as a policy response at the tip of our tongues - from ministers to bankers and newspapers, and even men and women in the street. At the back of their minds, they are encouraged by their appreciation of the beauty of the concept called "the multiplier."

Mathematically, "the multiplier" is nothing more than just a simple series. If you first have the item "(1-c)Y", followed by (1-c)(1-c)Y, and (1-c)(1-c)(1-c)Y, till infinity, then you can collapse the whole series neatly into a sum of "1/(1-c)Y." So, if c=0.8, then the multilpier is 5.

This multiplier was first put forward by Richard Kahn, a Cambridge professor, as some sort of a theory of employment and appended by Keynes to his Theory of Money and Interest to become the General Theory of Money, Interest and Employment.

If c is consumption out of income Y, then (1-c)Y is saved. This is a no brainer.

Now, the first assumption is that the savings of (1-c)Y is fully invested. There is no necessity of that. In an economic recession like today, may be a fraction or none of (1-c)Y is invested. So, if the government were to pump in a stimulus package G, then cG will lead to consumption and the remaining (1-c)G may be saved in the banks or leaked abroad.

When there is leakage out of the system, there is a need to put more and more in. So G1 will be followed by G2 and G3 and so on. This series of stimulus package has been going on for years in Malaysia. The multiplier just does not get cranked up.


There are two factors:
(1) type of investment
(2) confidence.

Type of Investment

Keynes never discussed the type of investment in any detail; it would seem he even brushed it off as "employing men to dig holes in the roads and fill them up again." Unfortunately, this little off-handed remark - as a result of trying to persuade the Treasury at the time to spend money - has been used much too common by politicians today to justify dubious projects at the slightest hint of an economic slowdown.

You may think that is good - in keeping the economic growth rate up; but it also has the damaging effect of prolonging its much needed adjustment.

This is what we are seeing in Malaysia. We have been propping up the construction sector that has the effect of creating jobs of illiterate foreign workers, while we have forgotten to create jobs for the young graduated we have generated in our universities. I think there is as much as problem of a mismatch in the education sector where supply has been expanded without the attendant increase in demand for graduates.

There is a need to expand the educated sector of the economy so that we can keep the size of the uneducated in abeyance - whether in construction or politics.

My point is that, instead of thinking in terms of the "stimulus package" with its "multiplier effect" where there is none, it may not be too late for us and if possible the government to come up with a development plan to raise the value-added of the economic activities of the country.

This must work through the education system, giving room for education to be translated into innovative ideas and hopefully commercially-viable ideas, and a stage for the display and execution of these ideas. I am of course talking about industrial ideas - but I am also thinking of agricultural ideas as well as ideas in the services industry - which must include the arts - music, art, drama.

I think the idea of developing areas in other places of the nation outside the Klang Valley is also a very good way of spreading development nationwide. This will create jobs in their neigbourhood instead of getting job seekers to leave their families. It is also a good chance to allow those outside the Klang Valley to make some money, instead of concentrating the wealth of the nation in the hands of a few in the Klang Valley.


Although Keynes talked a great length on the effect of confidence on investment, it was in the negative sense - that the loss of confidence has caught investors to run away and keep cash (if at home) and I presume invest abroad (if they have a chance to take their money out).

Let me elaborate the point on confidence in the Malaysian case.

For the moment, confidence is generated by the immediate economic prospect. In recent past, confidence came from government projects. In recent months, confidence jumped out of the window because of the US financial meltdown. Coming up with a modest package of government spending is not likely to have a stimulating effect - for the economy or anyone.

What is important for the country - if the economy is to pick and grow consistently in the coming 20 to 30 years - is for the people to have confidence. Confidence, in this case, comes from credibility of policy or a clear direction for the future (not the V2020 type). We see political troubles ahead because of ideology. We see more political troubles ahead because of the economy.

It has been asked why some countries with high taxes can have high economic growth? The answer: confidence. The high taxes are used to fund a social safety net so that all citizens know they will be taken care of when they are sick or old, so that they are willing to plough back what they earn into the system, after having spent all that they want to enjoy the life that they imagine.

Where does the system come from? Not from migrant workers; it comes from the work of every citizen in the various segments of the society in which they live.

It is therefore against the grain of nation-building to be pitching one group against another, to be excluding any group from the productive workforce, to be inadvertently sabotaging the national system by filling in important positions with wrong skills.

1 comment:

de minimis said...


This post has got to be your absolute top one of all. Your keen insight shines through very strongly. The economic managers need to have a clearer idea of how to set proper strategic goals instead of pandering to political parochialism. You are showing the way.

I can almost feel the beginnings of a major magnum opus on economics from you that may lead to a much-needed and long overdue review of Keynesian economics.