The multiplier and the rate of return on aid

by on January 25, 2013 at 8:42 am in Economics, Uncategorized | Permalink

Critics of “austerity” are often weak or a bit mumbly on what is the relevant alternative or counterfactual.  When it comes to the U.S., the relevant alternative is borrowing more, but in many cases, such as in the European periphery, the alternative is/was more aid.

So, in these cases, a multiplier of one means that a dollar of aid — the alternative to the fiscal consolidation — is worth a dollar.  I find that easy to believe.  It’s not really a claim about fiscal policy or Keynesian economics.

A multiplier of 1.4 means that a dollar of aid brings $1.40 in benefits.  Imagine receiving aid, and not just benefiting from the dollar, but avoiding a fire sale of your assets or investing the money wisely or maybe just avoiding a civil collapse.  That’s more of a stretch, but also not outside the realm of the possible.

As the IMF becomes more critical of austerity, the IMF therefore should believe in higher rates of return to aid.  But does it?

@Yannikouts nailed it here:

It’s one thing IMF economists to argue for softer austerity and a totally other thing to convince IMF Board members to commit to extra funds

Few people believe in austerity when it is someone else’s money on the line.  Here is my earlier post How emigrants try to run their fiscal policies.

Ashok Rao January 25, 2013 at 9:12 am

Frankly, it would be great if there could be a full US-EU free trade zone. Nothing as good as something for nothing. In fact, I’m really surprised this crisis has resulted in such harsh austerity before smart free trade agreements. Instead, the politicians want to pass “symbolic” tax codes (huh?) and fight Google.

Also doesn’t help that only a rather elite group of people want a really united Europe (probably more or less the same people for whom austerity is not a lifestyle concern).

dan1111 January 26, 2013 at 3:45 am

Yes, that would be great, but you should definitely not be surprised by it. If people recognized the value of a US-EU free trade zone, it would have already existed, regardless of the crisis.

I’m not sure how that would relate to the need for austerity. Would free trade with the U.S. really boost the budget enough to avert disaster in a place like Greece?

I also think that, in large part, the elites are less in favor of austerity than the general public. They only support it in other countries, and only when, as Tyler noted, the alternative is sending large amounts of their own money to those countries.

DocMerlin January 25, 2013 at 9:35 am

The IMF, the organization who’s first advice to countries that are falling appart is “raise taxes.”

Millian January 25, 2013 at 10:15 am

“As the IMF becomes more critical of austerity, the IMF therefore should believe in higher rates of return to aid. But does it?”

Yes, it does. They revised their estimated multipliers upwards. That is why they have become more critical of austerity.

Rob January 25, 2013 at 10:24 am

They say so, but have they actually increased aid spending? “By their works shall ye know them”, and all that.

Millian January 25, 2013 at 12:01 pm

Those who pay the piper call the tune. The IMF cannot really fund countries independently of those who fund the IMF.

Jim January 25, 2013 at 12:55 pm

Then the relevant counterfactual for getting money to start getting the multiplier going would be what for these countries?

Oz Ozzie January 25, 2013 at 3:47 pm

“the IMF therefore should believe in higher rates of return to aid”

Really? doesn’t it merely have to believe that the rate of return of aid is *higher than the alternative*, not higher than 1?

To use a (partially wrong, I know) household analogy – if I’m bankrupt because of debt, the lender lending me additional money so I can still afford to go work is going to come off behind, but not as far off behind as if I am forced to sell the car and can’t even go to work anymore

Philo January 26, 2013 at 10:30 am

“A fire sale of your assets,” i.e., a sale at a very low price, is bad for you, but good for the buyer. Over all, it’s a wash.

The Anti-Gnostic January 26, 2013 at 10:46 am

Re: “aid” in general, if a sovereign state can’t exist without aid, why should they be considered sovereign? Why do places like Kosovo or Haiti even exist as sovereign states? Why does Greece still have its sovereignty given that it took out loans with no means of repayment? If Greek, Irish, Icelandic or Cypriot taxpayers can’t or won’t make good on their States’ debts, then they either default and live within their means or cede their sovereignty in exchange for the continued flow of funds. If you’re a remote backwater in central Europe, you’re probably better off under the Austro-Hungarian Empire than your own brutal, corrupt chieftains.

Kevin C. January 26, 2013 at 1:24 pm

+1

Nyongesa January 28, 2013 at 1:32 am

Do you want Sovereignty over Haiti?, cede to who?. The U.N.!, somehow given the modern global political system, you-and-me-U.S. taxpayer will still end up paying, regardless of who is technically sovereign.

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