Could the American recovery plan work in the UK?

A key goal enunciated by the President-Elect concerning the American Recovery and Reinvestment Plan is that it should save or create at least 3 million jobs by the end of 2010.  Ms. Romer and Mr Bernstein* have undertaken a preliminary analysis of the jobs effects of some of the recovery packages being discussed. The good new is, the report suggests the plans will create sufficient jobs to meet the President-Elect’s goals.

After all it’s a big package around $775 billion approximately 5% of GDP over two years. But no need to worry, Romer and Bernstein suggest the plan will lead to an increase in GDP of 3.7% and an increase in jobs of 3.7 million. Mission accomplished.

The model is based on three critical numbers, firstly the size of the stimulus, secondly, the extent to which the stimulus impacts on GDP growth, finally the extent to which the GDP growth leads to a reduction in unemployment. The key numbers are known as the multiplier and the Okun co-efficient. (Bit wonkish but stick with it).

Romer and Bernstein use the multipliers equivalent to 1.5 for government spending and less than 1 for tax cuts. As for the growth : employment ratio “A conservative rule of thumb is used that a 1 percent increase in GDP corresponds to an increase in employment of approximately 1 million jobs, or about three-quarters of a percent".  An Okun co-efficient of 1.33.

Not everyone is happy. Paul Krugman* has challenged the Obama plan suggesting the package is not strong enough. Yet according to his own model, the plan generates around 4.5 million jobs over the two year period.

According to Krugman, “the per-year effect of the plan on GDP is $510 billion. Since it takes $300 billion to reduce the unemployment rate by 1 percentage point, this is shaving 1.7 points off unemployment". The equivalent of 2.3 million jobs in each year. Whats the beef?

So how about the UK? Unemployment is set to rise to between 9% and 10% within the next five quarters. Assume we wish to create or save 1 million jobs over this period or reduce the rate by 3%. Using the American multipliers and Okun ratio we require a stimulus package equivalent to 4.5% of GDP around £60bn over the two years. Forget the tax cuts, the multipliers are useless. With spending you get a much better bang for the buck.

Who said economic modelling was difficult?

The Job Impact of the American Recovery and Investment Plan : Romer and Bernstein
Christina Romer : Chair designate Council of Economic Advisers Jared Bernstein : Chief economist designate to the Vice President.
Dr. Romer on the Job Impact of the American Recovery and Reinvestment Plan - video

Krugman.blogs.stimulus-arithmetic-wonkish-but-important