World Bank Research: The Multiplier Doesn’t Exist

More and more, in a globalised world with many trade linkages, the evidence suggests that the macroeconomic orthodoxy of the past thirty-forty years is actually correct (abstract):

How large is the government spending multiplier ? evidence from World Bank lending

This paper proposes a novel method of isolating fluctuations in public spending that are likely to be uncorrelated with contemporaneous macroeconomic shocks and can be used to estimate government spending multipliers. The approach relies on two features unique to many low-income countries: (1) borrowing from the World Bank finances a substantial fraction of public spending, and (2) actual spending on World Bank-financed projects is typically spread out over several years following the original approval of the project. These two features imply that fluctuations in spending on World Bank projects in a given year are in large part determined by fluctuations in project approval decisions made in previous years, and so are unlikely to be correlated with shocks to output in the current year. World Bank project-level disbursement data are used to isolate the component of public spending associated with project approvals from previous years, which in turn can be used to estimate government spending multipliers, in a sample of 29 aid-dependent low-income countries. The estimated multipliers are small, reasonably precisely estimated, and rarely significantly different from zero.

To be fair, this looks at low-income, aid-dependent economies with low capital stock. Since World Bank projects typically rely heavily on imported capital, it should come as no surprise that the calculated multiplier effects would be low to negligible i.e. there’s lots of leakage. Incidentally, this also calls into question the desirability of obtaining World Bank funding for infrastructure projects in the first place.

But I digress – just add this to the list of research that weakens the case for anti-cyclical discretionary government spending policies as a viable macro-management tool. As an aside, did anyone notice that the estimated long term multipliers for many of the announced ETP projects are less than one?

Technical Notes:

Kraay, Aart, "How large is the government spending multiplier ? evidence from World Bank lending", World Bank, Policy Research Working Paper no. WPS 5500, Jan 2011