There's been lots of alarmism from interest groups about the impact of sequestration on teachers, security, White House tourism and congressional janitors. In addition, many commentators are arguing that it is wrong to reduce the burden of government spending in a weak economy -- no matter how small the actual cuts are. The evidence of the supposedly devastating impact of spending cuts, we are told, can be seen all over Europe. The solution, then, is to boost the size of government.
Second, an increase in government spending won't help the economy grow today. After years of debate over the impact of government spending on economic growth, we don't find much support for this Keynesian world view. Notwithstanding the confidence of stimulus advocates, there is no academic consensus regarding the size or even the sign (plus or minus) of the multiplier used to calculate economic growth created by $1 in government spending. As my colleague Matt Mitchell and I explained in a paper last year, the largest recent estimate is 3.7 while the smallest one is -2.88. In some cases, government projected as a boon for the economy, sometimes as simple waste, and sometimes as destructive.
This wide range of estimates exists, in part, because there are many different circumstances in which so-called stimulus might be applied. However, many of the circumstances that are theoretically necessary for stimulus spending to trigger large economic growth aren't present in the U.S. currently. For instance, while government spending is more likely to have a large economic impact when interest rates are low -- as is the case today -- it is also more effective if it takes place in a low-debt environment and when stimulus hasn't been tried before. Well, that's hardly the case today.
Another reason to be skeptical about government spending as a growth agent is that the money must be distributed just as Keynesian theory says -- timely, targeted and temporary. As it happens, this is more difficult than you may expect. Targeted spending, for example, goes to those areas that have been hardest hit by a recession. The goal is to spur growth by putting idle resources -- for example, unemployed workers -- to work. In 2011, George Mason University's Garett Jones and the American Enterprise Institute's Dan Rothschild surveyed companies and workers who received stimulus money and they found that nearly half of workers hired with American Recovery and Reinvestment Act money were poached from other organizations, not from unemployment lines.
Also, a recent paper by the Federal Reserve Bank of New York looked at whether the funding was targeted toward areas with high unemployment rates. Their answer: not really. In their summary, the authors write: "Our analysis of the distribution of ARRA funds across states shows that the expanded assistance to unemployed workers was indeed highly correlated with state unemployment rates. It turned out, however, that most other state allocations had little association -- positive or negative -- with state unemployment rates."
The good news is that we don't have to look too far to find examples of countries that have successfully reduced their debt and as a result healed their economies. In the 1990s, the Canadian government decided to tackle its debt problem by restraining the burden of spending. Central government spending as a share of GDP fell from 22 percent in 1995 to 17 percent in 2000, and reached the all-time low level of 15 percent of GDP in 2006. As the same time, Canada's debt-to-GDP ratio plummeted from 70 percent to less than 30 percent, and the economy was better as a result. It is time we give real spending restraint a chance.