Monday, June 07, 2010

Harvard Study: Pork Crowds Out Private Activity

From a study by three Harvard Business School professors titled "Do Powerful Politicians Cause Corporate Downsizing?":

"We show that becoming a powerful Senate or House committee chair results in a significant increase in federal funds flowing to the ascending chairman’s state. Thus, a congressman’s ascension to a powerful committee chair creates a positive shock to his or her state’s share of federal funds that is virtually independent of the state’s economic conditions.

We focus specifically on the 232 instances over the last 42 years where the senator or representative of a particular state ascends to the chairmanship of a powerful congressional committee. During the year that follows the appointment, the state experiences an increase of 40-50 percent in their share of federal earmark spending, and a 9-10 percent increase in total state-level government transfers. The funding increase persists throughout the chair’s tenure and is gradually reversed upon his departure. Because these spending shocks are sufficiently numerous, are spread out across time and different locations, and are economically meaningful, they provide us with significant power to examine the impact of fiscal policy on the private sector."

MP: Wouldn't you think that those increases in federal earmark spending and state-level government transfers would have overwhelmingly positive effects on state economies? Not necessarily, which is why the answer to the question in the paper's title is YES

"We find that fiscal spending shocks appear to significantly dampen corporate sector investment activity. Specifically, we find statistically and economically significant evidence that firms respond to government spending shocks by: i) reducing investments in new capital, ii) reducing investments in R&D, and iii) paying out more to shareholders in the face of this reduced investment opportunity set. Further, we find that when the spending shocks reverse (through a relinquishing of chairmanship), most all of these behaviors reverse. Finally, we also find some evidence that firms scale back their employment, and experience a decline in sales growth.  Our findings demonstrate that new considerations may limit the stimulative capabilities of government spending."

11 Comments:

At 6/07/2010 4:25 PM, Anonymous Craig said...

Though I find the conclusions of this study absolutely delicious, I can't bring myself to believe that there's anything more here than correlation. That is, how could more government spending cause a decrease in private investment?

Now, I have never believed that pork-barrel spending actually improves an economy. It's usually dumped down a political money hole that might provide a blip in consumption spending but does nothing for long-term capital growth. So, if there is more to this study than mere correlation, there must be other factors at work.

Were these primarily high-tax states prone to elect big-government liberals? If so, the decline in private business investment might simply have been a result of bad policy that was concurrent with more government largesse. I'd love it all to be true, but it just doesn't smell right yet.

 
At 6/07/2010 5:56 PM, Anonymous Mika said...

Individuals familiar and experienced with research statistics know that a slight apparent statistical "correlation" does not establish "cause and effect". Whether or not a slight statistical correlation is truly "significant" rests in the eye of the beholder - in this case researchers eager to prove their hypothesis. When you read the study you find that many of the correlations were very small - not at all supporting the title's claim of "crowds out". One suspects that if researchers examined other variables, one may likely find other explanations for the corporate behavior that are unrelated to the pork. Nevertheless, this paper was interesting.

 
At 6/07/2010 6:21 PM, Anonymous morganovich said...

craig-

there are lots of ways public spending can crowd out private investment. this has been the disastrous result of most african aid programs. if food comes in trucks and is given away, why farm or open a store? foreign micro lenders keep local banks from forming.

if federal pork comes to build high speed rail, why invest in competing infrastructure? if subsidized public loans are available, private lenders are forced out.

if the town puts in a skating rink, why would a private business compete with it even if they had been thinking about opening one. the public rink scuttles their plans.

government pork also increases the likelihood of monopolies. if you get the pork, you can under price everyone else, they know it, and don't enter, so you get one cable company instead of 3. that reduces private investment as well (and raises prices).

it's much less desirable to compete on a slanted field with someone who is getting free infrastructure from the government, so any subsidy will push out other investment.

consider the investments ford and other US car plants might have made if GM had gone under. all that investment was blocked by propping up GM who can no compete more aggressively than before and take share.

 
At 6/07/2010 9:09 PM, Anonymous Anonymous said...

Craig crowding out occurs by the following mechanism. The government spends money, which is likely newly printed for the purpose, on politically favored projects. There is no required return on these projects as the government does not get a return as a stock or bondholder would. Furthermore because this "investment" is not expected to pay investors a return, the project itself would be undertaken at expected returns below those expected on the open market. This government sponsored project will use up inputs such as raw materials and labor raising prices for these inputs precluding their use by industries that might otherwise use them if had not been outbid by the government project which is not required to yield a similar risk adjusted return as the private project. In summary, government spending causes resources to be used in inefficient projects and because all resources are scarce they cannot be spent on the private project.

 
At 6/07/2010 10:31 PM, Blogger W.E. Heasley said...

The study points out a dynamic of “crowding out”. The finding of the study affirms other empirical studies pointing to the same basic economic phenomena of “crowding out”.

The political-economy aspect of the study is interesting. The assent to chairmanship, in many cases is due to political tenure, which then lends itself to the concept of term limits. Further, is “chairmanship” akin to sitting on the “board of directors” of the political class? That leads to one to see that tenure and chairmanship, in the realm of the “political class”, as in other organizations, act as ultimate as well as interactive incentives.

 
At 6/08/2010 1:37 AM, Blogger Ron H. said...

This comment has been removed by the author.

 
At 6/08/2010 1:43 AM, Blogger Ron H. said...

"Individuals familiar and experienced with research statistics know that a slight apparent statistical "correlation" does not establish "cause and effect". Whether or not a slight statistical correlation is truly "significant" rests in the eye of the beholder"

Actually, Mika, you must not be a member of that group or you would know that as used in statistics, the word "significant" has an exact meaning, and doesn't "rest in the eye of the beholder". Significant describes a result that is unlikely to have occurred by chance.

You are correct that "correlation" does not establish "cause and effect".

 
At 6/08/2010 2:34 AM, Anonymous Anonymous said...

Porky jobs tend to be good paying and relatively low demanding. So the crowding out may be due to the lack of available workforce at reasonable wages.

Look what's going on with health care legislation, taxes, and regulations. Costs are going up and there's every indication that the same exact symptoms will show up except not just in a specific area. Reduced R&D, reduced capital investment, and higher return of money to shareholders.

Costs are costs. Raise them directly or indirectly and businesses will react predictably.

 
At 6/08/2010 3:59 AM, Anonymous Ian Random said...

Or like West Virginia, you could just pave the whole state over in highways named after a former KKK member. With no place to build a business, there goes the economy. :-)

I suspect that most megaporkers and anti-business types go with the same ideology. The left claims to want to help people, yet put in the most egregious barriers to everything imaginable as quickly as possible. Yes, I do disagree with the right on stuff, but at least they acknowledge private business.

 
At 6/08/2010 1:26 PM, Anonymous Mika said...

Ron H, you and I do fully agree. Obviously, I didn't make my point very clear, however. Yes "statistically significant" is an exact conclusion generated by the numbers which is not subject to opinion. However, finding a slight statistically significant correlation often doesn't result in a compelling argument that two variables have a genuinely strong relationship to one another. That's what I meant by "truly (actually) significant". We all know of the classic humorous examples of researchers finding a "statistically significant" correlation between two obviously totally unrelated variables.

 
At 6/08/2010 2:46 PM, Blogger Ron H. said...

"We all know of the classic humorous examples of researchers finding a "statistically significant" correlation between two obviously totally unrelated variables."

Yes, the one that comes to mind right away is the relationship between random numbers and hockey stick shaped graphs.

 

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