Last week, there was sad story in the Washington Times reporting that the District of Columbia has received more than $855 million in federal economic stimulus funds since 2009, but that this spending had not been shown to produce any significant improvement in the city’s jobs outlook. As a third-generation Washingtonian, it would be easy for me to blame the failure of federal stimulus to actually do any stimulating on the congenital dysfunction of the D.C. Government. Instead, I think the lesson learned here is that despite its intentions, government stimulus just isn’t that helpful in creating new private sector jobs regardless of geographic location.
As it turns out, we looked at this very issue last year in a paper entitled Can Government Spending Get America Working Again? An Empirical Investigation. Rather than contemplate the average or typical effect of government spending on private-sector jobs as many of the studies in this field typically do, we divided the past fifty years of U.S. economic history into low-growth and high-growth periods. We then applied a non-linear, two-regime model to study whether the stimulus effects of government and private investment differ between recessionary and expansionary periods.
And guess what? During periods of economic sluggishness (such as the current situation), we found that government spending has zero effect on private-sector job creation. This result is consistent with the apparent impotence of huge federal government spending increases aimed at reducing unemployment. In contrast, when it comes to job growth, expansions in private investment are effective in both regimes, but its efficacy is greatest during economic stagnation. By implication, policies that discourage private investment may have more severe job-killing effects during economic downturns, since it is during the low growth periods that private investment is most effective at creating jobs.
To illustrate this point, we calculated the employment effects of a hypothetical 5% increase in private investment (about $90 billion in 2005 dollars) and the equivalent dollar increase in government spending. As set forth in Table 2 from our paper below, based on the computed multipliers, an additional 432,000 jobs would accompany this 5% increase in private investment during the low-growth period. In contrast, an equivalent $90 billion increase in spending by the government would produce no net jobs in the low-growth period. For the high-growth periods, however, the $90 billion in government spending or private investment both would generate over 200,000 jobs. Be sure to note the significant increase in the potency of private investment in the low-growth regime (another 432,000 jobs) relative to the high-growth regime (just over 200,000 jobs). This differential effect is informally consistent with the idea that periods of higher growth are coincident with higher levels of resource utilization, so increases in demands may involve displacement and price rises to a greater degree. Other explanations are also possible.
The results from our two-regime non-linear model are important for policymakers. First, government spending does not appear to be an effective stimulant for private-sector job creation during periods of slow economic growth. As such, the federal government simply can’t spend the U.S. out of high private-sector unemployment. Second, private investment has a positive effect on job creation during low and high growth regimes, but the jobs effect is more potent effect during periods of low growth. Based on the historical data, therefore, stimulating private investment, not more government “stimulus” spending, appears to be the key to labor market recovery in the current economic environment.
We are not alone in our assessment of the government’s inability to stimulate private sector jobs. In a recent paper (January 2012), Professor Valerie Ramey (University of California, San Diego), a leading researcher in the area of government spending and economic activity, presented econometric evidence regarding the response of job creation to shocks in government spending. Using a variety of econometric models and datasets, Professor Ramey summarizes her findings as follows: “I find that increases in government spending lower unemployment. Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment. I thus conclude that on balance government spending does not appear to stimulate private activity.” (Emphasis supplied.) Therefore, despite using different techniques and different samples than our own analysis, Professor Ramey’s analysis and our paper reach the same conclusion—government stimulus cannot be counted on to increase private sector employment.
Accordingly, in light of these results and the evident failure of government stimulus to restore economic growth, job creation appears best served, under present economic conditions, by policies that encourage efficient private-sector investment. By most accounts, including President Obama’s, this means at minimum reform of the nation’s regulatory bureaucracy.