Crowding out private investment

May 25, 2010
TVA

Fontana Reservoir

In The Library in St.Pete you will find Amity Shlaes’ The Forgotten Man, in which Shlaes recounts how the TVA crowded out Wendell Wilkie’s Commonwealth & Southern, a private-equity-backed company ($400 million as reported in Wilkie’s testimony before a House committee) that was in the process of bringing electricity to the rural South.

Since the TVA could borrow unlimited funds at low interest, and did not have to turn a profit, C&S eventually had to sell its properties in the Tennessee Valley to the TVA in 1939 for $78.6 million.  (Fwiw, those events led to Wilkie’s 1940 presidential run.)  71 years after that transaction comes a new study which explores government spending on economic development and its effects on private investment.

Harvard professors Lauren Cohen, Joshua Coval, and Christopher Malloy look at increases in local earmarks and other federal spending that flow to states after the senator or representative rose to the chairmanship of a powerful congressional committee.  The surprising result:  as a result of government spending in their states, companies actually  retrenched by cutting payroll, R&D, and other expenses.

In Companies Retrench When Government Spends, the authors offer three potential explanations:

Some of the dollars directly supplant private-sector activity—they literally undertake projects the private sector was planning to do on its own. The Tennessee Valley Authority of 1933 is perhaps the most famous example of this.

Other dollars appear to indirectly crowd out private firms by hiring away employees and the like. For instance, our effects are strongest when unemployment is low and capacity utilization is high. But we suspect that a third and potentially quite strong effect is the uncertainty that is created by government involvement.

…Our findings suggest that they should revisit their belief that federal spending can stimulate private economic development. It is important to note that our research ignores all costs associated with paying for the spending such as higher taxes or increased borrowing. From the perspective of the target state, the funds are essentially free, but clearly at the national level someone has to pay for stimulus spending. And in the absence of a positive private-sector response, it seems even more difficult to justify federal spending than otherwise.

The implications of these findings for how best to nurture the growth of entrepreneurial companies are interesting.  There will no doubt be private growth companies that benefit from government subsidies in areas such as cleantech and alternative energy, given the magnitude of the dollars being spent.  But it would seem government could do far more to encourage sustainable entrepreneurial activity more broadly by insuring that the proper tax incentives are in place for new company formation and then also working to keep the regulatory burdens at a minimum.  If government does that consistently over a long period of time, the right incentives plus greater certainty will encourage a surge in new entrepreneurial ventures.  

 

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