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Research Surprise: Government Stimulus Hurts Local Companies

Three Harvard Business School researchers wanted to learn how much businesses benefited from increased earmark spending as their local congressional delegation moved up the leadership ranks to control powerful committees.

What they found out shocked professors Lauren Cohen, Joshua Coval, and Christopher Malloy. Instead of helping local businesses grow, federal spending in the state actually had the opposite effect. Many private companies retrenched. Specifically:

  • In the year that follows a congressman's ascendancy, the average firm in his state cuts back capital expenditures by roughly 15 percent.
  • There is some evidence that firms scale back their employment and experience a decline in sales growth.
"It was an enormous surprise, at least to us, to learn that the average firm in the chairman's state did not benefit at all from the unanticipated increase in spending," Coval told me in this interview for HBS Working Knowledge. "Indeed, the firms significantly cut physical and R&D spending, reduce employment, and experience lower sales."
Talk about a stimulus surprise. What's going on? The research doesn't directly address this question, but Coval believes some of the federal dollars are used to undertake projects the private sector was planning to do on its own. Also, the government-backed activities crowd out private firms by hiring away employees. Finally, government involvement breeds economic uncertainty for companies, and uncertainty can lead to retrenchment.

Coval suggests federal policy makers may want to look at this research and reconsider, or at least fine tune, their belief that federal spending stimulates private economic development.

I'm interested in hearing from companies that have seen this dynamic up close. Have you pulled back your business operations when federal funds came washing into your district?