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Does government spending create jobs?

I was talking to a very bright friend the other day about government spending and Keynes. He said something like, well of course spending on infrastructure creates jobs, it has to. He’s in good company. Here’s Steven Pearlstein writing in the Washington Post:

the last time I checked the textbooks they still say that deficit spending by the government actually increases employment and economic activity. To believe otherwise is to believe that hundreds of billions of dollars in tax cuts and stimulus spending somehow disappeared from the economy without a trace.

In this view, the job creation impact of government spending is simply a matter of arithmetic. In the Pearlstein view–and he is right, it is mainstream textbook analysis–when you spend money, you create jobs. Is my friend right? Especially when you spend money on infrastructure, aren’t you guaranteed to create jobs?

He is right that if the government builds a bunch of bridges, there have to be workers to build the bridges. So in that sense, spending creates jobs. As I have pointed out before, a very small percentage of the stimulus package went to spending on what we would call infrastructure. According to John Taylor, writing in September, 2010, only $2.4 billion of the stimulus had been spent on infrastructure. But let’s focus on the dollars that actually went to build roads and bridges. Is my friend right? Yes, there is a payroll with employed people. But did the spending create jobs? Usually we would mean by that question, new jobs, or more jobs on net than there were before.

To answer that question, you’d have to look at where the workers came from. Were they unemployed before they were hired to working on the bridge? If their leaving created job openings at their old firms, did that create an opening for an unemployed worker? If the skills of bridge building are somewhat specialized, then the effect of the spending on new bridges is to raise the demand for workers with those skills. That will in turn increase the wages of workers with similar skills, making them less desirable and somewhat offsetting the increase in workers on the bridge. Then there are the raw materials used to make the bridges. The increase in demand for those materials will also increase the price of those materials, discouraging their use and possibly reducing employment elsewhere, partially offsetting the workers hired to build new bridges. So it is hard to say what the full impact on the net number of jobs will be. And the answer would also depend on where the funds came from to build the bridges. Taxes? Borrowing? Printing money? All of these will have an impact elsewhere in the economy. But I think the deeper way to ask the question is not to focus on new jobs vs. net jobs, but on the very ideas of jobs.

Suppose the government hires people to dig holes and fill them back in. I pick that example for two reasons. One, Keynes used the argument twice in The General Theory. In Chapter 10:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

And again in Chapter 16:

“To dig holes in the ground,” paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services. It is not reasonable, however, that a sensible community should be content to remain dependent on such fortuitous and often wasteful mitigations when once we understand the influences upon which effective demand depends.

The second reason is that I heard Joseph Stiglitz agree to this with a straight face when asked by a member of Congress. (The video is here. If anyone has the patience to find the time mark or transcribe the Q and A, much appreciated.) Keynes and Stiglitz both said it would be better to do something productive, but even unproductive labor would have a stimulative effect.

I would make a different observation. If the government pays people to do stupid unproductive things, these are not really jobs. The “workers” receiving a “salary” are really just on a glorified version of unemployment compensation or welfare. The digging of the holes is just a tax, a punishment, the hoop you have to jump through for getting your government check. No one else would pay you to do it. There is nothing productive accomplished. The practice will end as soon as the government program ends. So in what sense has the government created jobs. You could just as easily call everyone who receives unemployment compensation, a “worker” and eliminate unemployment that way.

I am really only making a pretty simple point. Expanding the federal payroll via bridge building, or hole digging, or fighting a war for that matter, may or may not create jobs on net. And there is no reason to think that you have integrated these workers back into the economy or done anything productive. That depends on what you have them do. Having them do nothing–either because the task is unproductive or because you simply give them a check with no strings attached–does not in and of itself create prosperity for anyone other than the people who get the check. But what about the Keynesian multiplier? What about the spending that these people do in turn once they have their checks and go and buy other stuff. Won’t that in turn create new employment? It could. Or it might not. As I have written before, it could just increase prices without increasing output. Or output could go up because of productivity increases–people working harder–instead of more people working.

Is this really reasonable? Is it really possible to inject all kinds of money into the economy without getting more jobs? We know it’s possible just like we know that it’s possible to create all kinds of jobs without spending more money. To say it in the most simple terms: when the economy is healthy, you don’t need to spend money from outside to create more jobs. And when the economy is not healthy, all the spending in the world won’t create jobs. In the latter case, consider Zimbabwe, that prints too much money. Or the example I’ve given before of foreign aid designed to alleviate poverty. The money comes from outside the economy. But countries receiving foreign aid designed to end poverty don’t get rich. They stay poor. Their economies are broken. Giving their people money doesn’t create jobs. The necessary institutions and culture simply don’t function well there. And on the flip side, think of soldiers coming home from WWII at a time when government spending was going to collapse. How did they manage to find jobs? It was easy. The economy was healthy. The Keynesians predicted catastrophe and they were wrong. Or look at women joining the work force in ever larger numbers over the last 50 years. How did they manage to find work. Jobs emerged from the economy somehow for them to have. We didn’t have to worry about sticky wages or boosting demand. The economy was healthy.

Today the economy is not healthy. Something is broken. Not totally. Unemployment isn’t 25%. It’s 9.6.%. But the summer of recovery is over. There wasn’t much recovery, at least on the jobs front. The Keynesians will tell you that the stimulus worked but we just didn’t do enough. My take is that the stimulus did little to repair what was broken.

And what exactly is it that is broken? What is unhealthy? Consumers are spending again, at record levels. The simplest answer is that businesses are not investing. Investment is still very low. I’d like to hear the case of how government spending lots of borrowed money encourages business to invest. It would be a hard case to make. It seems to me that government spending of borrowed money, especially on unproductive stuff, discourages business investment. But I’m not sure that’s the right way to think about it. It’s not obvious that caution or restraint in business investment is the reason the labor market is so mediocre. Arnold Kling talks about recalculation and “Sustainable Patterns of Specialization and Trade.” He helps me think about what is going on, But there is more than that. Why is it that it is sometimes easy to recalculate or create new patterns of trade and specialization such as the time after WWII or for most of the time that women were entering the labor market in ever larger numbers. It is a mystery that we don’t fully understand. But what I think I do understand is that the link between government spending and jobs is not nearly as automatic as many people think.