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Government spending reduces private sector spending via another mechanism.

This paper employs a new empirical approach for identifying the impact of government spending on the private sector. Our key innovation is to use changes in congressional committee chairmanship as a source of exogenous variation in state-level federal expenditures. In doing so, we show that fiscal spending shocks appear to significantly dampen corporate sector investment and employment activity. These corporate reactions follow both Senate and House committee chair changes, are present among large and small firms and within large and small states, are partially reversed when the congressman resigns, and are most pronounced among geographically-concentrated firms. The effects are economically meaningful and the mechanism – entirely distinct from the more traditional interest rate and tax channels – suggests new considerations in assessing the impact of government spending on private sector economic activity.

So, let’s review the impact government spending has on the private sector:

  1. Government spending crowds out private investment via the interest rate mechanism we learn in basic economics.
  2. Government spending has to come from somewhere. So every dollar spent by the government is one less dollar spent by the private sector (the Keynesians dispute this – they think that I hoard money under my mattress, so that they can spend freely without crowding out my spending).
  3. Not only does government spending have to come from somewhere, but we need to raise taxes to do it. The taxes are highly distortionary. See here for an illustration.
  4. Government spending possibly causes inefficient allocations of labor and capital in the private sector either due to rent seeking or due to a change in the relative prices of labor and capital due to the tax and spending programs.
  5. Government spending results in some government monopolies – eliminating the incentive for private companies to compete there.
  6. Now, we add to this list, the above mechanism.

Of course, governments are the drivers of innovation, the multipliers on spending are well over 1, and all good things ever invented have come because of the good grace and vision of the anointed ones in DC.

2 Responses to “In Addition to Crowding Out”

  1. Harry says:

    “Government spending possibly causes inefficient allocations of labor and capital.”

    Possibly?

    I’m not one to accuse Wintercow of being a wuss, since he daily fights for the truth most courageously while the forces of the government and the academy muster their armies against him and his family.

    Now that I’ve qualified my comments carefully, I take exception with the word “possibly”.

    The whole progressive argument is based on the notion that free markets make bad descions — that when one examines each transaction there are undesirable consequences. For Marx, who thought in a framework of class, employers paid what he thought was too little. Hence free markets were inefficient and unfair. He never said, “possibly.”

    What has been empirically proved is that Marx and all of his intellectual descendants have failed miserably, a fact that Wintercow affirms.

    Wintercow, I know you use “possibly” to further the discussion.

    I would like someone to give me a single example of when the government has ever allocated labor or capital efficiently. (Efficiency is the ratio of output over input.)

  2. wintercow20 says:

    The left would offer up a clever definition of efficiency. If, in a normative sense, they define it as something akin to “achieving some objective” then of course going to the moon was a great investment by Uncle Sugar.

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