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Home Publications Blogs Beat the Press Theory, Stimulus, Unemployed Workers and Unemployed Politicians

Theory, Stimulus, Unemployed Workers and Unemployed Politicians

Monday, 21 June 2010 03:58

In his NYT column today Ross Douthat picked up on a line of attack initiated by Tyler Cowen last week: that the push for stimulus is asking politicians to take big risks based on a theory. To paraphrase a former president, this depends on what your definition of "theory" is.

We always take actions based on our expectation of how the world will respond. This expectation can be called a theory, since we have a whole set of postulates about how the universe behaves. If fire fighters hook up a hose to a fire hydrant, it is because they have the expectation that when the hose is connected, that water will run through it and that the water will quench the fire. We can follow Tyler Cowen and Ross Douthat and call the belief that motivates the fire fighters' actions a theory, but it is a theory that is grounded in considerable evidence.

Presumably Douthat and Cowen don't object to the fire fighters hooking up hoses to fire hydrants to put out fires; their concern is that the evidence for stimulus is weaker than the evidence that hoses connected to hydrants put out fires. To my mind, the evidence for the effectiveness of stimulus is roughly comparable to the evidence for the effectiveness of fire hoses hooked up to hydrants in putting out fires, but this would be a very long story.

It might be more interesting to note what passes for contradicting evidence in current debates. A few weeks ago, the NYT published a short piece by Edward Glaeser that showed no correlation between the amount of stimulus spending awarded by state and the change in the unemployment rate from January of 2009 and March of 2010. This piece of evidence against stimulus was promptly cited by David Brooks in his column the following week.

Should Glaeser's finding have left supporters of stimulus disappointed? Well, if we look to Glaeser's source, we would see that he was looking only at the $61.4 billion in stimulus spending on infrastructure projects that had been received by the states by the end of March of 2010, not the entire stimulus package.

There are several reasons why we would not have expected to find much of an effect in this analysis, first and foremost, its size. This money was awarded over a 13 month period over which GDP would have been almost $16 trillion. This means that Glaeser was looking for differences in the change in unemployment rates by state based on spending that was less than 0.4 percent of GDP over this period.

We would expect spending equal to 0.4 percent of GDP to increase GDP by roughly 0.6 percent of GDP, once the full multipler effects are felt (although not all within one state -- more later). According to the assumptions used by the Obama administration in laying out its stimulus plan, this would be expected to increase total employment by roughly 600,000 workers (some demand is met by increased hours per worker), or by just over 0.4 percentage points. Of course, this is the average gain in employment due to this spending, Glaeser was looking for differences in the change in unemployment based on differences in spending.

This would be difficult to detect even in a very stable economy. Picking up the impact of such a relatively small amount of spending over a period in which the unemployment rate rose from 7.7 percent to 9.9 percent would be virtually impossible even if the data were perfect, but they are not.

First, the measure of spending is money received by state, not money actually spent. Some states may spend money as soon as they get it from the federal government or possibly even beforehand, if they know it is coming. Other states may still be in the process of taking bids on contracts for some of this money even after they have received it. This means that there would be no close relationship between money received and the jobs created by the stimulus.

Second, we would not expect there to be a one to one relationship between stimulus per state and declines in the unemployment rate for two reasons. First, much of the money will support jobs that go outside of the state. Suppose New York City spends lots of money improving its infrastructure, thereby creating a large number of jobs. Many of the people hired will no doubt live in New Jersey and Connecticut. Glaeser's methodology would find little evidence that this spending lowered unemployment since the effect would be diffused throughout the three states. This would be the case with many states with metropolitan areas that overlap state boundaries.

This problem would be even more important with the indirect employment created by the respending of income. While some of this money may be spent on services provided in the local economy (e.g. hair cuts and restaurants), much of it will be spent on goods that were manufactured all over the world, making it even harder to detect any relationship between stimulus spending per state and changes in the unemployment rate.

A second reason why there could be little relationship between changes in unemployment rate by state and stimulus spending is that the unemployment rate measures people who are looking for work, not jobs. This number may actually rise when there are more jobs created. People often drop out of the labor force in a period of high unemployment because they feel it is futile to look for work. This means that they are not counted as being unemployed. When they start to see jobs being created, they begin to look for work again, raising the unemployment rate.

This effect is well-known. That is why economists who are seriously looking for a relationship between employment and stimulus spending would look at jobs created by state rather than changes in the unemployment rate. This would also help to get around the state spillover effect since we would look at which state the employer is in, as opposed to the state where the worker lives.

Finally, Glaeser's time periods do not coincide. He looking at spending that was allocated from mid-February 2009 until the end of March 2010. He compared this to the change in the unemployment rate from January 2009 to March of 2010. While the endpoints are reasonably close (the March data is compiled based on a survey conducted in the middle of the month), the start points do not match and it matters.

The unemployment rate rose from 7.7 percent to 8.2 percent between January 2009 and February 2009, an increase of 0.5 percentage points. Presumably we would not expect the state by state distribution of this rise in unemployment to be affected by a stimulus package that was not even approved until the following month. This one-month increase in the unemployment rate was larger than the expected effect of the stimulus.

In short, it would have been astounding if Glaeser's methodology had found a relationship between stimulus spending and changes in the unemployment rate by state, even if the stimulus was working exactly as predicted. Yet, this little exercise is taken as serious evidence against the effectiveness of the stimulus.

Getting back to the Douthat/Cowen complaint that the belief in stimulus is only a theory, it would not be difficult to create equally flimsy evidence showing the ineffectiveness of fire hoses in putting out fires. Fortunately, this evidence would not be taken seriously by anyone with fire fighting responsibility. The main difference between the theories of fighting unemployment with stimulus and fighting fires with water pumped through fire hoses is what is accepted as evidence against the theory. This takes us to the sociology of the economics profession, which is a very bad neighborhood.

What is a mild-mannered politician concerned about getting re-elected supposed to do? Well, there are theories about this as well. Most of them show that politicians do very badly in their quest for re-election in periods of high unemployment. So, it is not clear that the proponents of stimulus are asking politicians to take too great a risk when they suggest hooking up the fire hose and trying more stimulus.

Comments (11)Add Comment
written by Jake, June 21, 2010 7:14
Nice post, but you shouldn't just play defense here. Economists, and especially libertarians, have no problems recommending policy based on "theory." Often this theory isn't as well established or applicable as the physics of fire hoses. In fact, there is often massive evidence to these theories or the assumptions on which they rely. You should have given examples of this.
Hose still has plenty of water
written by AndrewDover, June 21, 2010 8:20

According to http://www.recovery.gov/Pages/home.aspx

The American Recovery and Reinvestment Act of 2009 has spent only around half of its funding:

Spent, Category, (Total authorized)

163, Tax Benefits, (288)
132, Entitlements, (224)
115, Contracts, grants, and loans, (275)

So a good chunk of the water is still in the hose.
That's a Fact, Not a Theory
written by izzatzo, June 21, 2010 8:24
Leave it to a stupid liberal like Baker to ignore the heritage of Factual Reality grounded in Constitutional Originalism that has guided the US to prosperity for over 200 years free of socialist theory. For example:

1) Japan is just a theory. It doesn't actually exist as a verifiable fact. It's a mirage, an hallucination. It couldn't possibly exist given its unsustainable ratio of debt to GNP and the absence of inflation, and that's a fact, not a theory.

2)The WWII spending claimed to pull the US out of a depression in the '40s is just a theory. What really did it was pent up savings during the war which created a spike in aggregate consumption under the pre-Keynes theory of Say's Law where demand equals supply at full employment at all times, and that's a fact, not a theory.

3) The sun rotates around the earth and the earth is flat, and if you don't believe it, walk outside and see for yourself. That's a fact, not a theory. No need to rely on some socialist Enlightenment Age Theory that claims otherwise.

4) The BP oil spill was caused by the prohibition of drilling in ANWR, volcanoes cause global warming, Hitler was a vegetarian therefore all vegetarians are Nazis, corporations are persons therefore all persons have equal economic freedom, stimulus spending doesn't create jobs because it crowds out other jobs in a deep recession. These are facts, not theories.

There's only one objective reality pursued by all as demonstrated years ago by Ayn Rand, grounded in rational self interest that is predictable and therefore creates maximum economic welfare and stability in the absence of government interference, and that's a fact, not a theory.
WWII & the Great Depression
written by Ellen1910, June 21, 2010 8:59
If enslaving 15 million workers to perform unproductive work (the draft) and lowering the standard of living of the remainder to one not seen in 30 years is what an economy needs to be pulled out of depression, might as well follow Mellon's "Liquidate! Liquidate! Liquidate!" advice.
written by skeptonomist, June 21, 2010 9:07
izzatso gives the Randian arguments as a satire, but the "real" Randian arguments by Greenspan in the WSJ are funnier.
"It's just a theory." — sound familiar?
written by Hugh Sansom, June 21, 2010 9:09
The most obvious parallel that comes to mind with Ross Douthat's and David Brooks's ill-informed and hypocritical screeds is that of religious right-wingers decrying evolutionary theory.

The "It's Just a Theory" condemnation of evolutionary theory has been around at least since the Scopes "Monkey" trial of 1925. Creationists — renamed "Intelligent Design" advocates — still grasp at the "just a theory" line, but not as much as they used to.

Maybe Douthat and Brooks will eventually catch up to the Creationists.
written by Don Beal, June 21, 2010 10:12
I am off topic bu because your website does not generate a lot of comment I hope you (Dean Baker) will notice and drive a movement. Pete Peterson got a big old wet kiss in my local newspaper (Oregonian) today on the editorial page. They got a shill law firm to write an editorial publicizing usabudgetdiscussion.org. An astroturf effort by Peterson to give heft to his cat food commission. I joined as an "online ambassador" to try to destroy it from within. Hopefully you will note this organization and get other bloggers from the left involved.
wow, ayn rand citations!
written by andy, June 21, 2010 11:42
to all those out there who think that this recent economic crisis was caused by govt. interference, well, if we had left the stock market and the housing market all to themselves we'd be pretty much in the same predicament. the crowds, the market, can be pretty stupid
Risks based on theory
written by Randy Fritz, June 21, 2010 12:22
I wonder who criticized the free marketeers who, for the last three decades (at least) made HUGE changes in how our economic world works based on their theories of unfettered markets? Now, all of a sudden, a stimulus is a "theory." Let's compare the costs of another stimulus to the costs of laissez-faire (which, of course, never really existed).
too hard for people to understand
written by floccina, June 21, 2010 3:37
What is a mild-mannered politician concerned about getting re-elected supposed to do? Well, there are theories about this as well. Most of them show that politicians do very badly in their quest for re-election in periods of high unemployment. So, it is not clear that the proponents of stimulus are asking politicians to take too great a risk when they suggest hooking up the fire hose and trying more stimulus.

It is too hard for people to understand that Governments are not subject to the same spending constraints as people are. Also jealousy is a factor, people in the private sector often view Government jobs like lottery winnings where the lucky few that get Gov. jobs get early semi-retirement with hiring to grave care. So they say Gov. should have to belt tighten like the rest of us.

Therefore IMO competitive free banking is the only solution. With competitive free banking the median voter need not know about money.
written by zinc, June 22, 2010 6:46
Meanwhile, these two, (at least Brooks), had no trouble trumpeting the theoretical stimulus effect of the budget busting Bush tax cuts for the wealthy. Even now, in the after-math of the Bush economic disaster, they refuse to "see" the correlation. It must be SS and Medicare.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.