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Posted by on May 27, 2010 in Economy, Politics, Society | 0 comments

When Unemployment Is Low, There Are More Jobs

Ed Morrissey flags a new Harvard Business School study that purports to show that government spending increases unemployment:

… the results of the new study by Harvard Business School will certainly shock some Keynesian academics — and high-ranking government officials.  Instead of providing a stimulating effect to the economy, government spending creates pressures on private industry to reduce staff and investment.  The study’s authors count themselves as among the shocked:

Recent research at Harvard Business School began with the premise that as a state’s congressional delegation grew in stature and power in Washington, D.C., local businesses would benefit from the increased federal spending sure to come their way.

It turned out quite the opposite. In fact, professors Lauren Cohen, Joshua Coval, and Christopher Malloy discovered to their surprise that companies experienced lower sales and retrenched by cutting payroll, R&D, and other expenses. Indeed, in the years that followed a congressman’s ascendancy to the chairmanship of a powerful committee, the average firm in his state cut back capital expenditures by roughly 15 percent, according to their working paper, “Do Powerful Politicians Cause Corporate Downsizing?

“It was an enormous surprise, at least to us, to learn that the average firm in the chairman’s state did not benefit at all from the unanticipated increase in spending,” Coval reports.

Ed, you will not be surprised to hear, is not surprised at all by these results:

… When private entities (citizens or businesses) retain capital, it gets used in a more rational manner, mainly because the entity has competitive incentives to use capital wisely and efficiently.  The private entity also has his own interests in mind, and can act quickly to use the capital to its best application.  Private entities innovate and look to create and expand markets, creating more growth.

In comparison, government moves much slower with capital.  It generally works to its own benefit and not that of private entities.  Lacking competition, there is no incentive for efficiency.  Most importantly, it rarely creates new markets or growth but instead creates a spoils system that ends up reorganizing the status quo to favor some and disfavor others.

I was, though (and I’m sure that will not surprise anyone, either). But since I am neither an economist nor particularly well-versed in the subject of economics, and since this study has apparently attracted very little blogger attention (judging by the discussion on Memeorandum), I decided to turn to my friend Google for help. Here is what I found right off the bat:  an interview with one of the authors of the HBS study, published at an in-house publication called Harvard Business School Working Knowledge. The interview included this information, which Ed did not mention in his piece about the study (emphasis is mine):

Q: Although you didn’t intend to answer this question with the research, what does your team suspect are some of the causes that could explain why companies retrench when federal dollars come into their neighborhoods?

A: Some of the dollars directly supplant private-sector activity—they literally undertake projects the private sector was planning to do on its own. The Tennessee Valley Authority of 1933 is perhaps the most famous example of this.

Other dollars appear to indirectly crowd out private firms by hiring away employees and the like. For instance, our effects are strongest when unemployment is low and capacity utilization is high. But we suspect that a third and potentially quite strong effect is the uncertainty that is created by government involvement.

Kevin Drum — one of the few bloggers who commented on this story — noted this caveat, too, as well as the fact that the increases in government spending examined in this study were random increases (emphasis is mine):

Three researchers at Harvard took a look at what happened to federal earmarks when a state’s senator or congressman took over chairmanship of a key appropriations committee. Answer: the state’s earmarks went up a bunch (by 50% for senators and 20% for House members). No surprise there. …
[…]
… So when federal spending goes up in a random way (committee chairmanships are generally unrelated to broader economic activity), capital expenditures by private industry goes down. A lot.
[…]
These are interesting results. But they need some followup. Even if you believe that government spending crowds out private spending in a serious way, the effect here is enormous. How can you possibly get an 8% drop in private sector capital expenditures from the relatively trivial increase in federal spending that comes from earmarks? There has to be something more to this story.

On the other hand, it makes perfect sense that whatever effect there is, is more pronounced when unemployment is low. That’s exactly when you’d expect government spending to crowd out private sector spending. However, it probably doesn’t tell us much about current stimulus spending, which is taking place in an environment of zero-bound monetary policy and extremely high unemployment. We haven’t had an environment like that since the Great Depression, which means that empirical evidence one way or the other on this kind of federal spending is just very hard to come by. I’d certainly be surprised if the 2009 stimulus bill provoked any significant private sector crowding out.

My tentative conclusion: The private sector is better at creating jobs when unemployment is low.

Duh.