The extent to which government spending either complements or crowds out private investment has long been one of the most heated debates in economics (and politics). Generally economic theorists posit that an increase in government spending drives up interest rates, which increases the cost of private investment, accordingly reducing such investment. Most macroeconomic models are build on this relationship.
In an interesting new working paper, a trio of economists attack the question from a different angle. They measure the impact of increased earmarks on the local economy receiving those earmarks, and compare the impact to areas not receiving the increased earmarks, which allows them to control for the overall macroeconomic environment. Their finding: even in a setting where government spending is “free” to the recipients (but not free to the rest of us), such spending reduces private investment.
More specifically, the authors examine what happens to a state when one of its senators becomes a chair of a powerful committee. First, the obvious, upon taking a power chairmanship, the value of earmarks increase almost 50%. This results in roughly a $200 million annual increase to the state. But the authors find this is not simply a transfer from the rest of the country to the state, it also depresses private capital investment and R&D spending in the state. On average, once a state has a senator obtain a powerful chairmanship, state level private investment in capital expenditures decreases $39 million annually and state private R&D decreases $34 million annually.
For states seeking to get your senator into a powerful chairmanship: be careful of what you wish for. There’s no free lunch, even when someone else is paying.