We are experiencing a rise in how much the government gets involved in the economy again, and I listen to many earnest 27 years olds who fervently believe their government work is critical. A recent study by the rational and dispassionate Harvard Business School shows that this belief, just like 1984's O'Brian's belief, is dangerously misguided. In fact, this Harvard study shows that government spending shuts down private sector activity.
I have certainly seen that government funding of NGOs and not-for-profits sucks up talented engineers and marketing people while the public sector struggles to find such skills.
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Here is the researcher's comments on their insights which they did not even mean to study:
Q: Although you didn't intend to answer this question with the research, what does your team suspect are some of the causes that could explain why companies retrench when federal dollars come into their neighborhoods?
A: Some of the dollars directly supplant private-sector activity—they literally undertake projects the private sector was planning to do on its own. The Tennessee Valley Authority of 1933 is perhaps the most famous example of this.
Other dollars appear to indirectly crowd out private firms by hiring away employees and the like. For instance, our effects are strongest when unemployment is low and capacity utilization is high. But we suspect that a third and potentially quite strong effect is the uncertainty that is created by government involvement.
Q: These findings present something of a dilemma for public policymakers who believe that federal spending can stimulate private economic development. How would you suggest they approach the problem that federal dollars may actually cause private-sector retrenchment?
A: Our findings suggest that they should revisit their belief that federal spending can stimulate private economic development. It is important to note that our research ignores all costs associated with paying for the spending such as higher taxes or increased borrowing. From the perspective of the target state, the funds are essentially free, but clearly at the national level someone has to pay for stimulus spending. And in the absence of a positive private-sector response, it seems even more difficult to justify federal spending than otherwise.
Christopher J. Malloy is an assistant professor in the Finance unit at Harvard Business School.
- More Working Knowledge from Christopher J. Malloy
About the author of the HBR articleSean Silverthorne is the editor-in-chief of HBS Working Knowledge.