President Obama has been trying to tamp down the maelstrom of ridicule that greeted his claim last week that the private sector was doing just fine -- but the public sector needed to be propped for robust job creation. Whether his remark was a political gaffe of the order of Mitt Romney's “I enjoy firing people” or “I don’t care about poor people” remains to be seen. But Obama’s comment accurately summarized prevailing Keynesian thinking on job creation, namely, that public sector spending complements –not crowds out -- private sector economic activity.
But a fascinating study by Harvard Business researchers Lauren Cohen, Joshua Coval and Christopher Malloy last year debunks this notion. The study examined the economic activity in 232 instances over the last 42 years when a senator or representative ascended to the chairmanship of a powerful congressional committee and then used his position to divert federal resources to his home state in the form of federal earmarks, contracts and transfers.
If the Keynesians were right, this “exogenous government spending shock” should have resulted in greater private sector activity, especially since this spending constituted “free money” that wasn’t financed by greater state taxes or borrowing. But, alas, the exact opposite happened:
Increased resources from the government that are not expected to be funded by taxes or borrowing induce individuals to increase their consumption and leisure. The resulting decline in the marginal productivity of capital compels companies to scale back investment and output…
Focusing on the investment (capital expenditure), employment, R&D, and payout decisions of these firms, we find strong and widespread evidence of corporate retrenchment in response to government spending shocks. In the year that follows a congressman’s ascendency, the average firm in his state cuts back capital expenditures by roughly 15%. These firms also significantly reduce R&D expenditures and increase payouts to their investors. The magnitude of this private sector response is nontrivial: in the median state (which receives roughly $452 million per year in increased earmarks, federal transfers, and government contracts as a result of a seniority shock), capex and R&D reductions total $48 million and $44 million per year, respectively, while payout increases total $27 million per year. These changes in firm behavior persist throughout the chairmanship and begin to reverse after the congressman relinquishes the chairmanship. We also find some evidence that firms scale back their employment, and experience a decline in sales growth in response to the government spending shock… (Emphasis added).
Our approach identifies a distinct and alternative mechanism by which government spending deters corporate investment. In particular, we provide evidence that crowding out occurs through factors of production including the labor market and fixed industrial assets. These findings argue that tax and interest rate channels, while obviously important, may not account for all or even most of the costs imposed by government spending. Even in a setting in which government spending does not need to be financed with additional taxes or borrowing, its distortionary consequences may be nontrivial.
President Obama might be satisfied by the job creation in the private sector. But one of the great mysteries of America’s post-recession economic recovery under his tenure has been why private companies have refused to add jobs and bring down the unemployment rate despite having returned to profitability.
Could it be because Obama’s trillion-dollar stimulus pumped easy money into the economy and made capital “lazy”? Why invest in expanding business and adding workers when you have easy government money at hand to keep shareholders happy?
And could it be that just as the economic health of states began to improve after they lost their powerful Congressional representatives, likewise the American economy will improve after Obama leaves office and all his stimulus threats finally end?
Just sayin…Not that I have any love lost for the alternative!
(Check out Hot Air’s Ed Morrissey’s blog illustrating precisely how weak job growth has been under Obama’s recovery compared to other post-recessionary periods, Obama's sanguine declarations to the contrary nothwithstanding.)