A “stimulus” is money spent by the government in order to kick start the economy. The basic premise is simple: The government spends money on purchasing goods and services, which lands in the hands of businesses and workers, who in turn have more money to spend, they buy things, and presto, the economy is booming again.

If it only were that simple. What’s wrong with it? Oh, just the usual. Negative side effects and unintended consequences of government action.

When the government stimulates the economy, it spends money, and that money has to be taken from somewhere. It’s all too easy to ignore the negative effects on whomever of whatever the money was taken away from and just focus on the wonderful things that happened to those who were given the money. That’s the fallacy of the stimulus!

This post presents some definitive evidence of the failure of government spending as a tool for stimulating the economy, and it is intended as a direct rebuttal to anyone claiming that Obama is such a great president because he “saved or created” X number of jobs, or that the economy would have been so much worse had Obama not done __________.

Let’s begin…

A 2010 Harvard Business School study set out to investigate how businesses benefit as their state’s congressional delegation grows in stature and is therefore able to bring in more Federal spending to the state.

Using data compiled from a 40 year period, the researchers discovered, to their great surprise, that as more Federal money flows into a state, its “companies experienced lower sales and retrenched by cutting payroll, R&D, and other expenses.”

And here’s why:

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.

All throughout 2009 and 2010, president Obama could not stop bragging about how many jobs he had “saved or created.” But of course, it’s very easy for the government to “save or create” a job. It’s a no-brainer. Just borrow, say $100,000, and pay a man to dig some holes and fill them back up again. And bingo, you’ve created a job. And if you contract a private company to do it, you can even be so bold as to call it a “private sector” job. Easy as pie.

So what’s the problem? The negative side effects and unintended consequences of course. What if, due to government action, for every job “saved or created” there are even more jobs “forestalled or destroyed”?

And this is exactly what happened, says another academic study, which you can read here.

The study concludes that at best the stimulus created no private sector jobs. The only thing it “save or created” were government jobs. The study further concludes that the stimulus has likely destroyed one million private sector jobs to create 450 thousand government jobs.

Here’s the abstract:

This paper uses variation across states to estimate the number of jobs created/saved as a result of the spending component of the American Recovery and Reinvestment Act (ARRA). The key sources of identification are ARRA highway funding and the intensity of state sales tax usage. Our benchmark point estimates suggest the Act created/saved 450 thousand government- sector jobs and destroyed/forestalled one million private sector jobs. The large majority of destroyed/forestalled jobs are in a subset of the private service sector comprised of health, (private) education, professional and business services, which we term HELP services. There is appreciable estimation uncertainty associated with these point estimates. Specifically, a 90% confidence interval for government jobs gained is between approximately zero and 900 thousand and the counterpart for private HELP services jobs lost is 160 to 1378 thousand. In the goods- producing sector and the services not in our HELP subset, our point estimate jobs effects are, respectively, negligible and negative, and not statistically different from zero. However, our estimates are precise enough to state that we find no evidence of large positive private-sector job effects. Searching across alternative model specifications, the best-case scenario for an effectual ARRA has the Act creating/saving a (point estimate) net 659 thousand jobs, mainly in government. It appears that state and local government jobs were saved because ARRA funds were largely used to offset state revenue shortfalls and Medicaid increases (Fig. A) rather than directly boost private sector employment (e.g. Fig. B).

If this is not enough, we now have another case study on how to get out of a recession by deploying opposite policies to the big government stimulus.

While the U.S. under Obama was attempting to get out of the recession by increasing government spending and expanding social programs, Germany has been cutting taxes, cutting spending, and restructuring its social programs.

This New York Times article from August 2010 details Germany’s economic recovery:

During the recession, Chancellor Angela Merkel resisted the palliative of government spending that the United States and some European partners felt was crucial to restoring growth.

By paring unemployment benefits, easing rules for hiring and firing, and management and labor’s working together to keep a lid on wages, Germany ensured that it could again export its way to growth with competitive, nimble companies producing the cars and machine tools the world’s economies — emerging and developed alike — demanded.