Want to get NC state lawmakers as excited as a kid on Christmas morning? Tell them that some “free” federal government money is coming to the state. We’ve also seen how excited local citizens get when their U.S. Representative “brings home the bacon” in the form of some federal government projects to their districts.
But are these things worth celebrating?
University of Michigan economist Mark Perry points to a recent Harvard study that conlcudes: “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.” (read the full study here)
In short, as I’ve argued before, federal spending does not “stimulate” economic activity at all. In fact, due to crowding out effects resulting from the diversion of scarce resources to politically-motivated projects away from profit-seeking ventures, states that receive boosts in federally-funded projects are left worse off.
Voters who are impressed with their Congressman because they “bring some of that federal money home to us” need to re-evaluate their position. That federal money will actually make your economy worse. Furthermore, state lawmakers should keep this in mind next time they have visions of all the glorious wonders that they believe accompanies “free” federal money.