Be very skeptical when you hear claims that some product or facility is going to have big economic effects. Usually, whoever is making the claim is making a gross error in reasoning. Two recent news items illustrate this.
The first was a much ballyhooed announcement recently by a JPMorgan Chase economist that the new iPhone could increase the annualized rate of U.S. gross domestic product growth by one-quarter to one-half percentage point. Given that the economy is only growing at 2 percent a year, this would be an enormous boost.
The basic argument was that the phones would sell for about $600 each and would have an import cost of $200. If 8 million are sold, the consumption component of GDP would increase by $4.8 billion and the net exports component would decrease by $1.6 billion. The net change to GDP would be an increase of $3.2 billion or 0.33 percent for the quarter in which the phones were sold.
In fairness, the JPMorgan analyst, who holds the position of chief U.S. economist, clearly said the effect would largely take place in one quarter, so the total addition to annual national output would be much less than that implied by the annualized rate trumpeted in the headlines that assume the growth would continue for four consecutive quarters at the same pace.
He also noted that sales of other brands of smartphones might drop and that this would have to be netted off. He further noted, however, that if the new phone has greater quality, i.e., more useful features per dollar spent, then the hedonic constant quality adjustment to GDP, that tries to take account of such factors, would result in an even greater output increase.
The huge error he makes, however, is to assume that if someone does not buy a new iPhone, or even a less-desirable competing model, they wont spend that money on anything else. They wont buy new clothes, go out to eat, go to the movies or buy new tires. They will simply set aside hundreds in available funds and do nothing with it. They wont even put it into some financial investment where it would be available for businesses to use it on new facilities or equipment. (This would go into the gross investment component of GDP.)
That 8 million people would simply tuck a wad of cash under their mattresses because a new iPhone was not available is simply preposterous. Yet that is the assumption implicitly made by the analyst. If this is the level of reasoning ability prevailing at the upper levels of Morgan, sell whatever stock you have in the company as fast as you can.
The second example in my hometown of St. Paul, Minn., which got $27 million in a competitive grant from the state to build a new stadium for a beloved minor-league baseball team. But it could have come from any city or state where economic development officials tout public subsidies for new sports facilities or to lure factories away from some other state or city.
The city got this money from the state in part because its proposal touted $10 million in added economic activity that building a new stadium would generate. This $10 million supposedly will come largely from additional spending by baseball fans on food and drink before or after games.
However, we already have an existing stadium for the team that has served well for 25 years. And people who go to games there do eat and drink before they go or have a few drinks after the game.
Now, do you really think that fans arrive at the existing stadium in a famished condition because they couldnt conceive of eating at a restaurant not on the same street as the stadium? Do you think that after the game, fans go home and, after having a glass of warm tap water, go to bed hungry? Do you think that if they are apparently unable to spend their money on having a good time before or after a game, they put the money in a coffee can under the rose bushes and dont spend it on anything else? Of course not! You are not going to generate an additional $10 million by moving a mid-size sports facility from one part of a city to another.
Nor do you add much for society as a whole by moving a factory from one state to another with government tax incentives or other subsidies. Yes, there is more economic activity in the new location, but there is a decrease in the old, abandoned location. The net change usually is modest indeed.
Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at email@example.com.