Public Spenders - Read This Before You Embark On Spending!

"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" --- Study by Harvard Business School 2011.

The trick which the authors apply to come to their conclusion is somewhat unique American: they have determined that whenever a committee in Congress gets a new chairperson, that new chairperson uses his/her influence to steer public/federal money into his/her constituency. In other words, increased public spending. They have measured that federal funds which flow into their constituencies increased by 9% during the first year. Public orders which are given to the private sector in those constituencies increased even by 24%. According to theory, that should make for a significant impulse for the private sector in the constituency.

The opposite development was observed. Private companies reduced their investment in machinery & equipment on average by 15%. Expenditures for R&D also declined, as did employment in R&D. The authors conclude that increased public spending seems to crowd out activities in the private sector.

Perhaps EU policy makers should take a look at this study.