Less Government Spending Can Boost Growth and Jobs

September 1, 2011

For release Aug. 31 and thereafter (765 words)

Keynesian economists, especially Alan Blinder and Nobel Laureate Paul Krugman, have been stridently outspoken recently about the notion that federal stimulus could destroy jobs. They are most concerned that this view is a threat to sound policy-making and that public opinion is swinging rapidly and heavily toward this conclusion. Some cite the dubious Congressional Budget Office estimates of at least 1.3 million net new jobs created in 2010 as a result of temporary stimulus. But for $800 billion of stimulus, this works out to $615 thousand per temporary job. Not so supportive of the Keynesian view, but even this estimate understates the job losses.

In fact, the hypothesis that federal spending destroys jobs is a well-founded and supported result. There is strong evidence that it is typically correct. Indeed, private-sector job destruction is often so strong that the net effect of the government spending is to reduce the overall number of jobs. This is not a novel idea, nor is it mythical. We need to take seriously the idea and fact that cuts in some types of government spending or taxes can be highly beneficial to economic performance and job creation.

About 50 years ago, a noted economist, Martin J, Bailey, formalized the notion that government spending can be a close substitute for private spending so that government provision of some goods and services could reduce the benefit or rate of return from private expenditures on such items and reduce private spending and employment. For nearly as long, there has been ample supporting statistical evidence that a rise in federal expenditures has no effect on aggregate demand, overall output and employment. Higher government spending is fully offset by reductions in private sector spending and that, in turn, requires that private-sector employment decline.

Keynesians think that this reduction in private-sector production and jobs only occurs when increases in government spending lead to higher interest rates that “crowd out” private-sector spending. And since interest rates generally fell during the recent explosion of federal spending, Keynesian economists consider the notion that jobs were destroyed to be absurdly implausible.

But government spending is often a substitute for private-sector output. As a result, crowding out is “direct” and does not depend only upon interest-rate developments.

When government spends more for some items, private consumers or businesses have incentives to spend less on the same or comparable items. Keynesians focus on the stimulus in fall 2008, i.e., more than $600 billion of spending and more than $200 billion of tax cuts. They do not mention that the tax cuts were temporary and that mainstream consumer theory indicates that such tax cuts are largely saved with no effect on employment. A large number of temporary tax changes dating back at least to the 1960’s bear this out.

Also, a large part of the increased spending was for public capital formation. There is strong evidence that such projects crowd out, directly, comparable private-sector investment resulting in no change in total output or jobs. John Taylor and John Cogan have demonstrated that the recent federal assistance to state and local governments, including for public capital spending projects, had no effect on state and local spending — or by implication, on public or private employment.

The current administration also has reduced jobs by increasing subsidies for not working and by increasing regulation. The surge in new regulations and subsidies has reduced the work effort and jobs of many who would otherwise have been in the work force. New regulations have also reduced the incentives to invest and to hire for innovative entrepreneurs, and especially investment and hiring in the financial and health care industries, where new federal regulation has exploded.

Keynesian blinders have to be extremely powerful to ignore the developments in economic thinking over the past half century and to miss the powerful evidence of the smaller but more numerous failed Keynesian experiments over the same period. Weak job growth is not a political myth; it follows from the types of policies we have adopted. We do not need to repeal the stimulus plan. That was baked in through the temporary nature of stimulus that is now gone.


But this temporary stimulus has now morphed into permanent stimulus that has expanded unprecedented budget deficits for the indefinite future. This is all new spending and the first order of business for increasing growth and jobs is to roll these increases back. Then the expansion can blossom. And Keynesians will be even more perplexed.     
 
John A. Tatom, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is associate professor of finance and director of research at Networks Financial Institute at Indiana State University. Dr. Tatom is a retired policy adviser and research official at the Federal Reserve Bank of St. Louis. Earlier he was head of Country Risk and Limit Control at UBS in Zurich.


Comments...

Leave a Reply

Your email address will not be published. Required fields are marked *