Sunday, July 15, 2012

Take the money and sit around

Who's lazy in neoclassical economics?

I ran across what appears to be a semi-famous study that has been understood (on the economic right) to defeat Keynesianism. A paper by Cohen, Covan, and Malloy (CCM) from 2009 claims that when states get free money from the federal government, their GDP goes down. This is perhaps a mini-resource curse, like the oil curse that leads to bad governance, corruption, and bad political as well as economic outcomes. As a non-expert, I can not entirely judge their work. (Other critiques, incuding a typically sultry one by David Brooks who implies that no economic theory fared well in this recession, which is not true.)

Their analysis is based on the natural experiment of changing political fortunes. When, in the US, the legislature changes hands, the new party in the majority takes over all the chairmanships that write budget bills, and in typically corrupt fashion, channels vast amounts of money to the chairman's states and districts. The same thing happens at a smaller scale when a legislator gains a committee chairmanship through natural attrition. CCM claim that these switches are essentially unlinked to other economic phenomena and form a natural experiment on the effects of exogenous money on otherwise stable economies.
"During the year that follows the appointment, the state experiences an increase of 40-50 percent in their share of federal earmark spending, a 9-10 percent increase in total state-level government transfers, and a 24 percent increase in total government contracts."
They put the Keynesian prediction as being that GDP would go up in these states, (through direct added money), and the neoclassical prediction that GDP would go down, due to impairment of investment incentives and general human laziness. They find that GDP goes down. Win for neoclassical economics?!
"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 R&D 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 R&D reductions total $48 million and $44 million per year, respectively, while payout increases total $27 million per year."
Note that these are not very large effects, compared with the government injections. Only a fraction of the new largesse is socked away as savings, share buy-backs, etc. Where does the rest go, if overall GDP is claimed to go down? CCM never say, and I speculate that this is an enormous hole in the analysis. Their metric of employment is also "firm-level" employment, (indeed restricted to publicly traded companies), ignoring the public sector and small business employment that would probably be the main result of increased federal money.
"Also, consistent with Keynes’ view that crowding out should only occur under conditions of full employment, we find a stronger firm response to spending shocks when state-level employment, state-level real GDP growth, and US real GDP growth are at or above their long-term historical averages."
"As Table VII reports (in Column 3), the coefficient on the main effect, which measures the response of firms in states during high unemployment times, is actually positive (albeit insignificant). Meanwhile, for firms in states during low unemployment times, the interaction term is -0.024 (t=2.17) larger, which indicates that the negative impact of seniority shocks on corporate employment is concentrated at times when the supply of employable labor is scarce." 
"This result can be interpreted as providing evidence consistent with the view that government stimulus crowds out private sector employment when the economy has little slack in the labor market, but does not when the economy is experiencing significant slack in the labor market."
Here is where they admit that when unemployment is high, stimulus raises their metric of firm employment and GDP, even if most of the money is going to government jobs. When unemployment is low, government competes for private sector jobs, and so their measurement of "firm-level" employment goes down. But they do add on an analysis of aggregate state data, which shows overall employment losses resulting from a political stimulus. Insignificant statistically, but negative. Why would that be?

They make a snide parting comment about West Virginia in their conclusion. But that state was plenty poor before the modern age of pork, so they were hardly thrown into some dark age by their success in the political pork-stakes. Other explanations are needed. Perhaps pork tends to entrench existing corporate as well as political interests, sapping innovation and growth in favor of rentier behavior.

It is interesting to note that the paper's tip-off word is "leisure", (appearing nine times), which is the alternate to economic productivity, implicitly stigmatizing workers. But "rentier" might be a far more accurate description of what is going on, since it isn't the poor who are choosing laziness and non-investment in response to federal injections, but the rich who are choosing political money over market money in this model.

Indeed, they are remarkably vague on the mechanisms that may lie behind their findings. The one concrete illustration they offer is the state of Senator Richard Shelby, Alabama, which netted 96 million dollars more earmarks as of his ascension to chairmanship of the Senate Select Intelligence committee. One Alabama company, building trailer homes, saw a decrease of 30% in its employment, which CCM explain as perhaps due to the $15 million that Shelby brought in for the actual stick-construction of low-income housing, hitting the related market for prefab homes. Nowhere do CCM account for the jobs added (or lost) in this other construction business.

So one might model the findings by proposing that classical theorists know particularly well of what they speak- that the business class is prone to laziness and rent-seeking, not the working class. Working people need jobs without fail, and look for jobs that fulfill basic desires for a decent life. The business class also looks for income, but this can be from passive investments or higher margins just as well as from new business creation. If they get the former handed on a platter, then why create new businesses? What if corruption pays better than trade & innovation?

None of this really speaks to Keynes. Yes, government spending is inefficient, particularly the ear-mark kind of spending that this paper deals with. But the authors themselves say that when labor markets are slack, the extra spending is not at all bad, and since they do not poll public sector or privately held companies, they may be missing a good deal of growth.

Note that what this analysis also says, in essence, is that the higher one taxes those "job creators", the harder they work. Which stands to reason, but isn't the story we have been hearing for the last few decades!

"Balancing the budget by drastically cutting spending and raising revenue was what the economy needed. “Nothing will put more heart into the country,” Hoover said."
  • Bonus economics figure. We need a carbon tax, and just how much carbon tax do we need? (An analysis focused on the nuclear industry.)

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