Stimulating Reading: How Ezra Klein’s Wonkblog is Helping the Romney Campaign

Earlier this week Ezra Klein’s Wonkblog in the Washington Post published an article titled “The Romney campaign says stimulus doesn’t work.  Here are the studies they left out.”  The article criticizes a Romney campaign paper by Glenn Hubbard, Greg Mankiw, John Taylor and Kevin Hassett for its selective references of empirical studies of the Obama Administration’s American Recovery and Reinvestment Act (ARRA).  The Wonkblog article, posted by Dylan Matthews, provides a list of 15 papers (most of which have not yet been peer reviewed) and claims that 12 of them find that the ARRA “worked.”

I decided to read a few of these studies to see how much empirical support there was, in the academic community, for the idea that the ARRA was effective.  I read four of the papers, and so far, I am underwhelmed by the empirical evidence.

I read three of the papers listed by Wonkblog as providing evidence that the Obama stimulus worked.  The first, by James Feyrer and Bruce Sacerdote estimated the impact of the ARRA on jobs at the state and local level.  They find that the ARRA had some impact on jobs but estimated that the cost of each job created was between $170,000 and $400,000.  In addition, they find that different types of spending have different effects on jobs.  For example they report that spending “to fund teachers and police have if anything a negative impact.”  In general, their results are supportive of the study by John Cogan and John Taylor that found that state and local governments used Federal stimulus funding to reduce borrowing rather than increase hiring.

Feyrer and Sacerdote cleverly control for the statistical problem that stimulus spending is generally larger in places where the economy is worse through a technique called “instrumental variables.”  Their study validates what many ARRA critics have asserted: the ARRA was in large part pork barrel spending.  They find that states where members of Congress have longer tenure in Washington received more stimulus spending.  Their study uses this variation in pork barrel spending to estimate the effectiveness of the ARRA.

A second paper listed by Wonkblog under the “stimulus works” category is “Measuring Tax Multipliers: The Narrative Method in Fiscal VARs” by Carlo Favero and Francesco Giavazzi.  This paper has nothing to say about the effectiveness of the ARRA; it relies on data through the first quarter of 2007.  (The purpose of the article was to reconcile two different methods for estimating the impact of tax cuts or tax increases on economic activity.)

A third paper listed as supportive of the ARRA is “Fiscal Policy Multipliers on Subnational Government Spending” by Jeffrey Clemens and Stephen Miran.  Again this paper has nothing to say about the effectiveness of the ARRA; it relies on data through 2004.  It is fair to say, however, that the authors find low multiplier effects of government spending programs, perhaps due to crowding out of private expenditures.  They state:

“our relatively low multiplier estimates (based on deficit-financed government spending) can be reconciled with the larger estimates in several recent studies (based on windfall-financed government spending) if government debt crowds out current private consumption and investment. We view these contrasting, but not contradictory, results as evidence of an important role for neoclassical considerations.”

Finally “The American Recovery and Reinvestment Act: Public Sector Jobs Saved, Private Sector Jobs Forestalled” by Timothy Conley and Bill Dupor finds that the ARRA had a slight positive effect on public sector employment and a slight negative effect on private sector employment.  They report that the largest declines in private sector employment were in health, education, and private business (HELP) services.  In particular they report that government employment increased by between zero and 900,000 jobs and private HELP service employment decreased by 166,000 to 1,378,000 jobs.  They report that ARRA had a negative, but insignificant, effect on private sector jobs in goods-producing industries.  Taken together, Conley and Dupor find the ARRA had no statistically significant positive impact on overall employment, and may have actually reduced employment.

 Dylan Matthews and the editors at Wonkblog apparently don’t understand what it means for a study to find no significant effect of a policy.  The Wonkblog article states “The biggest problem with the Conley and Dupor study is that their estimates are not statistically significant.”  What is true is that any study of the ARRA will be fairly imprecise and have limited statistical power because of a small sample size and the methods required so that estimates don’t obviously suffer from endogeneity bias.  Given the statistical precision of their study, Conley and Dupor could have detected a statistically significant increase in jobs in service-producing industries as small as 1.5%, if such an increase had occurred.  Conley and Dupor most likely found no positive effect of the ARRA on private sector employment because the stimulus was either ineffective or had such a small effect that it could not reliably be measured.

I have more reading to do, but my initial reaction is: two studies had nothing to say about the effectiveness of ARRA, one study found no positive effect on employment at all, and the other gave mixed results.  Even the study with mixed results found that the ARRA cost hundreds of thousands of dollars per job created and that the stimulus resembled political pork: spending was higher where Representatives had more tenure in Congress.  My primary conclusion is that Wonkblog has helped the Romney campaign by calling more attention to academic studies questioning the efficacy of the Obama Administration’s economic policies.

Fiscal Restraint and Casimir Pulaski Day

There has been considerable discussion this election year about the economic consequences of fiscal restraint.  Some economists believe that the economic recovery has been hampered by government cutbacks in particular spending programs.  A recent article in the Wall Street Journal noted that as state and local governments “get a handle on their finances” its “good news for tomorrow’s economy” but “straining today’s recovery.”

Downsizing institutions, public or private, is costly because it takes time for resources to be reallocated to other sectors of the economy.  However, wasteful government spending diverts resources from other more valuable uses and does not stimulate the economy.  There is no sensible economic argument, even in a weak economy, for delaying cuts in duplicative, ineffective or wasteful government programs.

President Obama’s jobs bill includes $35 billion of Federal aid for state and local governments to be used for teachers, police and firefighters.  Voters seem more likely to support this policy because they see the tangible benefits from this focused spending.  However, the President’s  support will dwindle if the pay and benefits of government workers seem excessive for the typical voter.  For example, a recent story in the Chicago Sun Times indicated that the average pay for a unionized Chicago firefighter is about $104,000 per year while the average full-time worker in Chicago earns $49,000 per year (according to the Bureau of Labor Statistics).

Chicago firefighters receive costly collectively bargained perks and retirement and health care benefits.  For example, firefighters in Chicago are awarded thirteen paid holidays and receive double time if they work on any holiday including Flag Day, both Lincoln’s and Washington’s birthdays, and Casimir Pulaski Day (March 4).  Democratic mayor Rahm Emmanuel is currently negotiating for limits on non-wage benefits in a new contract with the firefighters’ union (whose current five-year agreement ends in a few days).  Emmanuel is at the bargaining table with the same union leaders who helped elect him.  He knows that support for President Obama’s $35 billion spending package for teachers, police and firefighters will evaporate if voters believe that this money is not being spent wisely.

There are a number of areas where there is some bi-partisan support for government spending reductions.  The GAO recently released a report detailing $100 billion in possible savings by eliminating duplicative programs.  Senators Tom Coburn (R-OK) and Mark Udall (D-Co) and Representatives from both parties introduced legislation to eliminate duplicative government programs.  These cuts in spending will help the economy, even in the short run, and free up resources for more valuable projects.

Even wasteful government spending is difficult to eliminate because of vested interest in the status quo and the political power of government unions and contractors.  Al Gore, Jr. tried to reinvent government and Bill Clinton said the era of big government is over.  But, Ronald Reagan knew how difficult it is to achieve fiscal restraint.  He said: “No government ever voluntarily reduces itself in size.  Government programs, once launched, never disappear.  Actually, a government bureau is the nearest thing to eternal life we’ll ever see on this earth!”

Dyed-in-the-wool Keynesians believe all government spending stimulates the economy, even a holiday honoring Casimir Pulaski or an expensive junket to Las Vegas for GSA employees.  Keynesian economists who advocate government spending for its own sake are their own worst enemies.  Taxpayers will lose confidence in government solutions to economic problems if fiscal restraint is dismissed even as journalists report on government spending excesses.

Multipliers

We are producing more with fewer workers; U.S. employment is below the pre-recession peak of January 2008 but output (real GDP) is 1.2% higher.  Employment in the private sector and state and local government has declined over the past four years while Federal employment has increased.  Since January 2008:

  • Private sector employment declined by 4.5%
  • Federal government employment increased by 3.4%
  • State government employment declined by 1.6%
  • Local government employment declined by 2.8%

Is the decline in state and local government employment a drag on the economy as Paul Krugman has argued?  Or have state and local governments, like the private sector, become more efficient and deliver more and better quality services with fewer employees?  This is impossible to tell from National Income Accounts data which only measure the cost of government spending and not the value of the government services provided.

It is important to put the recent declines in state and local employment into perspective.  In the past fifteen years local government employment has grown almost twice as fast (17.5%) and state government employment has grown slightly faster (10.3%) than private sector employment (9.1%).  State and local government has grown relative to the private sector for decades.

The recovery/stimulus legislation was designed to bolster state and government spending.  However, as John Taylor testified to Congress, state and local governments used stimulus funds largely to reduce borrowing rather than increase expenditures.

Paul Krugman argues for more state and local government spending on goods, services and investment.  (He admits that “safety-net spending … has soared in this slump.”)  Keynesians believe that if spending were $340 billion higher (about 2% of GDP), GDP would be 3% higher due to the “multiplier” effect and the unemployment rate would be 1.5% lower.   A “multiplier” argument is a smokescreen for the real debate about the appropriate size and scope of government.  Some state and local government spending/employment cuts make sense if they eliminate waste and duplication but that is the opposite of what “multiplier” calculations would conclude.

In addition many leading economists such as John Cochrane and John Taylor are skeptical of large multipliers for stimulus spending.  More importantly, the “multiplier” argument says nothing about which programs should be expanded and whether any programs should be cut.  The emptiness of a “multiplier” justifcation for government spending is clear when one recognizes that Keynesians believe that government reductions in waste and fraud would lower GDP and raise the unemployment rate.

One of the most important election issues is the debate over the proper size and scope of government.  The debate would be more informative if it focused on the direct costs and benefits of government programs, assumed that programs must be paid for even if financed through bonds, and did not rely on possible “multiplier” effects to justify spending.

Infrastructure Spending and the Davis-Bacon Act

It’s been three years since the American Recovery and Reinvestment Act was signed into law.  Only 7% of the $840 billion in stimulus funds were allocated to transportation and infrastructure projects.  White House Budget Chief of Staff Jack Lew  recently said that a “crumbling infrastructure is not the way to build an economy that can last.”  The Obama Administration  has proposed spending hundreds of billions of additional dollars on roads, bridges and schools.  Common sense says that the Federal government should undertake those infrastructure projects where the benefits exceed the costs.  Unfortunately the Davis-Bacon Act inflates costs by requiring Federal contractors to pay the prevailing wage (plus fringe benefits) on construction projects.

Government infrastructure spending makes sense because borrowing costs are low; the 10 year Treasury bond rate is about 2%.  This argument would be bolstered if labor costs were also relatively low.  The Davis-Bacon Act, however, forces government contractors to pay artificially high wages and benefits.  This means that fewer projects will be completed for each billion dollars budgeted for infrastructure.

If the wages paid on government construction projects could freely adjust to market conditions, labor costs would be much lower in many parts of the U.S.  The following figure shows construction employment in three states particularly hard hit by the 2008 recession: Florida, Michigan, and Nevada.  Construction employment is down 40% to 62% from its pre-recession peak in these states.

The large demand reductions in the Florida, Michigan and Nevada construction industries put downward pressure on construction wages.  Davis-Bacon prevents this from lowering labor costs for Federal projects.  The U.S. Department of Labor sets the prevailing wage in each area based on surveys of unions and employers that are administered by its Wage and Hours Division (not the Bureau of Labor Statistics).

The 2012 prevailing wage in Las Vegas (Clark County) is about $50 per hour for carpenters and $60 per hour for electricians and power equipment operators.  I presume there are thousands of unemployed and underemployed construction workers in Las Vegas who would be willing to work for less than $50 per hour.

Prevailing wages that are unresponsive to current labor market conditions are not limited to Las Vegas.  The following figures show prevailing wages for plumbers and elevator mechanics in Wayne County, Michigan (Detroit) and Broward County, Florida in 2004 and 2012.  Since 2004, the prevailing wages of elevator mechanics increased by about 80% in Wayne County and by 90% in Broward County.  Over the past 8 years, plumbers’ wages increased by 40% in Broward County and by 67% in Wayne County.  These substantial increases occurred despite the collapse of the construction industries in Michigan and South Florida in the past decade.

The Works Progress Administration (WPA) had a much different approach for infrastructure projects from 1935 to 1943.  WPA wages were twice welfare benefits, but far less than the union pay scale, so that more workers could be employed.  The WPA also used excessively labor intensive methods to increase employment per project.

Inflated infrastructure costs are undesirable whether they are due to artificially high wages or an inefficient production process.  Ultra-Keynesians, like Paul Krugman, may advocate infrastructure spending as a stimulus even if production is inefficient or labor costs are inflated.  After all, Krugman recently argued that government spending for protection from imaginary space aliens would be beneficial.

The Federal government should undertake infrastructure projects where benefits exceed costs, allocate resources efficiently, and pay market wages.  The projected benefits of infrastructure projects should be based on the merits of each project not supposed stimulus effects.  Project costs should reflect market conditions.  Requiring contractors to pay their employees inflated prevailing wages produces no more stimulus than would a requirement that domestic bondholders receive 5% rather than 2% interest.  Davis-Bacon prevailing wage requirements were suspended in the aftermath of Hurricane Katrina.  The Obama Administration should consider suspending Davis-Bacon again so that contractor wages reflect market conditions, more unemployed construction workers can be hired and more worthwhile infrastructure projects can be funded.

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