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Federal Finance Minister Jim Flaherty (CHRIS WATTIE/CHRIS WATTIE/REUTERS)
Federal Finance Minister Jim Flaherty (CHRIS WATTIE/CHRIS WATTIE/REUTERS)

Neil Reynolds

The hidden cost of stimulus programs Add to ...

Harvard Business School professors Lauren Cohen, Joshua Coval and Christopher Malloy found a curious way to measure the economic impact of stimulus programs: They used Washington's most influential politicians as avatars of shock-and-awe spending. In a recent research paper ("Do Powerful Politicians Cause Corporate Downsizing?"), they get right to the point. "We find strong and widespread evidence of corporate retrenchment," they write, "in response to government spending shocks." In short, stimulus impairs the private sector economy that it purportedly seeks to revive.

In the U.S. congressional system, politicians with the most seniority control the most important committees - and routinely use this control to direct extraordinary increases in federal spending to the states they represent. In other words, they provide real-life models for the empirical study of off-and-on stimulus spending.

The three academics based their research on the 232 occasions in the past 42 years when either a senator or a representative ascended to the control of a big-budget congressional committee. In the typical case, they say, this seniority perk delivers an extra $200-million (U.S.) a year in federal funds for privileged states (some of it in infamous "earmarks," some of it in increased transfer payments). Again in the typical case, the increased funds keep flowing until electoral reversal or death intervenes - and redirects this sluice gate to another aging politician in another state.

As an example, the professors cite Arlen Specter (first elected: 1980), the Republican senator from Pennsylvania who - as an important committee chairman - wasn't the least bit shy of boasting. He once said: "My senior position on the appropriations committee has enabled me to bring a lot of jobs and a lot of federal funding to my state. Pennsylvania has a big interest in my seniority, a big interest." (His power of the purse notwithstanding, Mr. Specter nevertheless went down to defeat last month - following his defection to the Democrats - in a primary election.) What happens when supplementary spending of $200-million a year hits the neighbourhood? Mr. Specter obviously assumed, as conventional wisdom dictates, that the result would be jobs, jobs, jobs. This assumption, after all, is the silver chalice of Keynesian orthodoxy - and the priesthood gets agitated at the merest whiff of heresy.

Consider, for example, Finance Minister Jim Flaherty's response to Fraser Institute economists Niels Veldhuis, Amela Karabegovic and Charles Lammam - who examined Mr. Flaherty's $47-billion (Canadian) stimulus package and who dared to conclude (in a report published in May): "[It]didn't work."

Nor, they said, did stimulus spending do much in other countries. Citing research finding after research finding, Mr. Veldhuis, Ms. Karabegovic and Mr. Lammam declared that the conventional wisdom is wrong.

"A vast body of academic research casts serious doubt on the ability of government stimulus spending to boost economic activity," they said. "In plain English, increased government spending reduces, not increases, economic growth." Canada, using "discredited economic assumptions," went deeply into debt for nothing - and, perhaps, for less than nothing.

For his part, Mr. Flaherty dismissed Mr. Veldhuis, Ms. Karabegovic and Mr. Lammam as ideologues. Yet the Harvard Business School research came to the same heretical conclusion without a hint of ideological spin.

"In the year that follows a congressman's ascendancy," the Harvard professors say, "the average firm in his state cuts back on capital investments by 15 per cent ... [and]significantly reduces [its]R&D spending." Collectively, companies operating in this state reduce capital investment by $39-million (U.S.) a year and R&D by $34-million a year. Other consequences include increases in unemployment and declines in sales growth.

How can this be? Governments justify stimulus spending, and the national debt that accompanies it, solely on the basis of a super-sized "multiplier effect" - the belief that an extra $1 in public spending will generate an extra $1.50 in GDP. It was on the basis of a wealth-creating multiplier effect that the federal government justified its debt-driven stimulus program.

So: Does public sector spending complement the private sector - or does it hurt it? "This question ... has occupied economists for much of the past century," the Harvard researchers say. "[It]remains a critical, and unresolved issue." Yet their novel study supports the conclusion of skeptical economists who find stimulus spending an extremely dubious investment.

Public sector spending, these researchers conclude, does increase demand. But this demand, they say, is met by a simultaneous and comparable private sector retreat. And this decline persists until public sector spending returns to its usual level. Thus, stimulus spending, they say, "compels" private sector companies either to downsize or to move - either to another state with less public sector spending or to another country.

In his rather rude dismissal of Canadian economists Veldhuis, Karabegovic and Lammam, Mr. Flaherty described their work as "shoddy" and as "poorly done." In fact, it is persuasive. Readers, though, can judge for themselves. The Veldhuis-Karabegovic-Lammam report, "Did Government Stimulus Fuel Economic Growth in Canada? An Analysis of Statistics Canada Data," is available at fraserinstitute.org. It is urgent reading. It is essential that we stop Mr. Flaherty before he spends again.

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