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,
RD, 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 RD 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
RD 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.)