Don’t color Veronique de Rugy shocked, shocked to find that government spending crowds out private investment, but 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.
This surprising result does not come from a misapprehension about pork and its relation to the chairmanships of the committees. Indeed, the study shows that pork dollars flow in mighty streams from those chairs to home districts and states. It’s not just earmarks, either, but also legislative expenditures that increase:
The average state experiences a 40 to 50 percent increase in earmark spending if its senator becomes chair of one of the top-three congressional committees. In the House, the average is around 20 percent.
For broader measures of spending, such as discretionary state-level federal transfers, the increase from being represented by a powerful senator is around 10 percent.
In the year that follows a congressman’s ascendancy, the average firm in his state cuts back capital expenditures by roughly 15 percent.
There is some evidence that firms scale back their employment and experience a decline in sales growth.
If this seems counterintuitive, it might be from marinating too long in Beltway conventional wisdom. 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.
All of that is certainly true in the long-term sense. It now appears true in the short-term sense as well, despite the immediate application of government funds to specific areas. If this study is true, it calls into question the entire concept of Keynesian stimulus, and it shows that the Obama administration has gone in an entirely wrong direction both in concept and in practical terms in attempting to create economic growth. The best way to achieve growth appears to be to eliminate government interventions and to keep capital in the hands of the private sector. And that’s no shock at all to anyone who pays attention to economics.