Federal Earmarks Make State Economies Worse Off

This article appeared in the June 18 edition of the Charlotte Business Journal.

Want to get North Carolina state lawmakers as excited as a kid on Christmas morning? Tell them that some "free" federal government money is coming to the state.

Indeed, many of us can recall last year when Gov. Bev Perdue excitedly declared she would "drive a truck" down to South Carolina because she was so giddy over the prospect of North Carolina taking any federal recovery funds our southern neighbors may refuse. We’ve also seen how excited local citizens get when their U.S. Representative "brings home the bacon" in the form of federal government projects to their districts.

But are these things worth celebrating?

A study released in March by three Harvard Business School economists says no. The study examines the "impact of government spending on the private sector" of states in response to sudden increases in "state-level federal expenditures."

The Harvard economists use a novel approach to study this topic. The authors used changes in congressional committee chairmanships to track spikes in federal earmarks flowing to affected states during the sample period of 1991 to 2008. In other words, when a Representative assumes leadership of a powerful committee, his state suddenly receives a significant increase in federal funds for various projects.

Most observers would likely agree that such an increase in federal funds flowing into a state would be good for that state’s business, given all the economic "stimulus" sure to result from the new dollars.

The Harvard study, however, concludes just the opposite. "We find that fiscal spending shocks appear to significantly dampen corporate sector investment activity." The authors findings include a reduction in capital and R&D investment among the impacted states, and also "evidence that firms scale back their employment" after a spike in federal funds.

Specifically, the study’s authors note "the average firm in his state cuts back capital expenditures by roughly 15 percent," and that corporations reduce employment growth by 3-15 percent after a newly appointed committee chairman increases the federal funds flowing to his home state. The authors also found that accompanying the influx of additional federal funds is a reduction in corporate sales growth by "up to 15 percent."

Further bolstering the study’s conclusions is the authors finding that "when the spending shocks reverse (through a relinquishing of chairmanship), most all of these behaviors reverse." So as the amount of federal funding coming into the state is reduced, economic activity picks up once again.

The reason for negative economic effects coming after a windfall of supposedly "free" federal dollars is what economists refer to as the "crowd out" effect. The government-financed projects crowd out investments that would have otherwise been made by the private, productive sector of the economy. Because scarce resources in the local and state economies such as labor, land and equipment are diverted to politically-motivated projects away from profit-seeking ventures, states that receive boosts in federally-funded projects are left worse off.

The next time you see a smiling politician attending some ribbon-cutting ceremony in front of a federally-funded project bragging about how he "brought home the bacon" to his home state, know that there is no such thing as a free lunch. The evidence is in: bringing more federal funds to their home state may make for good headlines for the politicians responsible, but is bad for business.