Obama Spending Drive Will Suffocate Job Growth

Jan. 25 (Bloomberg) -- Private-sector jobs will be created. That's the argument President Barack Obama will present tonight in his State of the Union address to justify his plan for any federal spending increases.

The president will pay lip service to the idea that the era of throwing cash at the economy is over. Yet either because strapped state governors and unions are pressuring him or because he believes it, Obama is likely to insist that domestic outlays are investments, not waste.

So far, gains in private-sector employment haven't sufficed to bring unemployment below an unacceptable 9 percent. The president will say that federal spending on infrastructure and other grants are necessary to lower unemployment to tolerable levels.

You can also expect the president or pundits to mention a so-called multiplier effect, in which a federal dollar of spending generates more than a dollar's worth of economic activity.

Yet what if additional federal spending for roads, bridges, schools, and work programs in states doesn't redeem itself in jobs? Perhaps such spending actually impedes employment in the private sector. Maybe President George W. Bush killed jobs by signing off on stimulus spending. And maybe President Obama is doing more of the same.

Spending Studies

That's the conclusion of recent research by many economists, most notably Robert Barro, who has made the case that the multiplier is less than one, or that the economy is set back a bit for every public dollar spent.

For the past few years Price Fishback, a University of Arizona economist, and Valentina Kachanovskaya, a graduate student at the school, have been studying the effects of federal domestic spending from the point of view of individual states during the 1930s, a period of dramatic unemployment.

The authors' findings, published in a National Bureau of Economic Research paper, suggest that the government will suppress private job creation, or possibly kill jobs, if fresh big spending becomes law.

Fishback and Kachanovskaya start their research with the presidency of Herbert Hoover, who, along with Congress, increased federal spending by 52 percent from 1929 to 1933. Adjust to reflect deflation, and the Hoover figure is a disconcerting 88 percent.

Selling the Stimulus

They note that President Franklin Roosevelt also increased federal spending, albeit at a slightly slower rate. Both administrations pushed the message that such spending would create net new jobs. "Emergency employment was directly provided for varying periods for nearly 200,000 men and indirectly for a much larger number in industries that supply necessary material and services," said Hoover's Department of Agriculture. Under Roosevelt, officials calculated their multiplier: three dollars worth of economic activity was generated by one highway dollar.

The two Arizona economists see a more modest benefit. They find that each dollar of public works spending and funding jobs for the poor did increase the average amount of personal income, or cash an individual had on hand to purchase goods and services, by $1.67. When government spending under Hoover and Roosevelt involved grants and loans, the figure was $1.39. One example of such grant-or-loan spending was the Veterans Bonus bonds of 1936 that were convertible to cash.

No Jump-Start

After that, the news about multipliers gets worse. According to Fishback and Kachanovskaya, a dollar spent by Washington didn't jump-start job creation. The money may have had no effect or even suffocated nonfarm private-sector employment. The investment did not spill over to most other sectors of the economy in a positive way. A double dip, the depression within the depression, followed record federal investment in the economy in 1936.

These disappointing data matter because if ever there was an emotional case for federal spending to create jobs, it was the 1930s. Today, unemployment of about 9 percent is considered horrifying. In the 1930s, however, unemployment was between about 9 percent and 25 percent. Intuition tells us that in a country so desperate, federal outlays would increase private employment. They didn't.

The two economists say that today federal spending would be even less likely to create jobs. Other economists view government job creation differently but arrive at similar conclusions. "What is the logic that says if the private sector isn't creating jobs then the government can step in and do that?" asks Lee Ohanian, a labor scholar at the University of California Los Angeles.

Perverse Effect

Ohanian's study of the Great Depression suggests that political pressure and new statutes also designed to help private-sector workers did just that, for some. The moves raised wages. However, the higher wages discouraged employers from hiring new workers, keeping unemployment high.

Research by economic historian Robert Higgs shows federal stimulus spending during times of high unemployment slows hiring because employers don't know how long or deep the stimulus will be.

All of this tells us that states looking for handouts from Washington might want to reconsider. They may be hurting their constituents' ability to get jobs. The research also tells us that the best thing President Obama can do to help unemployment drop on his watch is to eschew more plans for spending altogether.

Ohanian is completing a book; Fishback is refining his thesis. The academic evidence will continue to mount, until federal spending is harder to justify, even when it is labeled "investment." If the cloud of this recession has a silver lining, it is that Americans are beginning to understand that spending help, even the investment variety, isn't the best way to get respectable growth.

(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Amity Shlaes at amityshlaes@hotmail.com

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

© Copyright 2011 Bloomberg

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