Sunday, February 26, 2012

Calculating program impacts

It can be very difficult to forecast the impact of economic legislation before it is passed, and just as hard to measure this even after the passage of time... So, for example, discussions of what was achieved by The American Recovery and Reinvestment Act of 2009 (ARRA) range all over the map - from Republicans claiming that it has exacerbated the economic problems of the country, to Democrats who insist that it was very successful in generating employment and economic activity and that the situation would be much worse had it not been passed, to positions in between....

A CBO report, 'Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from October 2011 Through December 2011', speaks to the methodologies used by The Congressional Budget Office to estimate the legislation's impact.

The first methodology is driven by the legislation itself... It required those who received over $25,000 as a result of the legislation to report on a quarterly basis a myriad of details about the projects funded and their impacts. If you summed them up this provided numbers of people employed, which could then be attributed to the effects of the legislation.

The CBO report points out the deficiencies of this methodology:

"However, the reported number of jobs funded is not a comprehensive measure of ARRA’s effect on overall employment or even of those provisions of ARRA for which recipients’ reports are required. The actual impact could, in principle, be significantly larger or smaller than the number of jobs reported. If, for example, recipients’ reports include employment that would have occurred without ARRA, the impact on employment suggested by the reports could be too great. Some people whose employment was attributed to ARRA might have worked on other activities in the absence of the law...

Conversely, the reported figure could be too low because the reporting requirement is limited to primary and secondary recipients of funds and thus excludes lower level recipients, such as subcontractors hired by a main subcontractor. Thus, if expenditures under ARRA led to increases in employment among lower-level subcontractors and vendors, those effects would be
missed by the reports.

Recipients’ reports also do not include indirect effects that could increase or decrease the impact on employment. Among those effects are potential declines in employment in other businesses or economic sectors as demand shifts toward the recipients of ARRA funding— a phenomenon often called the “crowding out” effect of government policies.

Conversely, spending under ARRA could lead to higher employment at companies that are not directly connected to that spending...

Finally, the recipients’ reports reflect only about one-fifth of the total amount of spending increases or tax reductions that are attributable to ARRA’s provisions. The reports cover direct government purchases of goods and services, grants and loans to private entities, and some grants to states and localities, but they do not cover tax cuts or increases in transfer payments to individuals.

So, the CBO turns to a second methodology. In this case it grouped all the ARRA provisions into a number of categories (see chart below) and then applied the historical "multipliers" (using a 'low' and a 'high' estimate for each category based on a consensus amongst economists) to the various expenditures at the various dates that they occurred... The output estimates thus obtained were translated into estimates of effects on employment and unemployment, etc.

This second methodology also has pluses and minuses... Per the CBO report:

"... A key advantage of the model-based approach used in this analysis is the ability to provide estimates of the total effects throughout the economy of the government spending, transfer payments, and tax cuts resulting from ARRA...

A key disadvantage of the model-based approach is the considerable uncertainty about many of the economic relationships that are important in the modeling. Because economists differ on which analytical approaches provide the most convincing evidence about such relationships, they can reach different conclusions about those relationships... For those reasons, CBO provides ranges of estimates of ARRA’s economic effects that are intended to encompass most economists’ views and thereby reflect the uncertainty involved in such estimates..."

However, unlike economists, most politicians don't go for estimates, ranges, or nuance! So, if the CBO estimates that between 0.7 million to 3.3 million jobs may have been created by ARRA in 2010, the administration will tout the 3.3 million figure!

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