The Government (Un)employment Effect

A few hours ago, the Obama Administration released a new report estimating that Stimulus II saved or created about 3 million jobs. Shortly thereafter, my colleague, Veronique de Rugy, testified before Congress on the impact of the stimulus. She argued, among other things, that more realistic estimates show that fiscal stimulus tends to do more harm than good.

All of this talk about jobs reminds me of one of Veronique’s recent posts:

Since the beginning of the recession (roughly January 2008), some 7.9 million jobs were lost in the private sector while 590,000 jobs were gained in the public one. And since the passage of the stimulus bill (February 2009), over 2.6 million private jobs were lost, but the government workforce grew by 400,000.

I will leave it up to you to draw conclusions.

In the spirit of drawing conclusions: one body of research suggests that the conclusions are not happy ones. A number of studies have examined the relationship between government employment and private employment, concluding that the former crowds out the latter. Using data from 19 countries over 17 years, Horst Feldmann (2006), for example, examined the relationship between a large government sector and unemployment. He found:

[A] large government sector is likely to increase unemployment. It appears to have a particularly detrimental effect on women and the low skilled and to substantially increase long-term unemployment.

What is more, Feldmann is not the only one to come to this conclusion. As he reports in his literature review:

Several empirical studies suggest that an increase in government expenditure impairs labor market performance. For example, Karras (1993) observed negative employment effects of government spending in eight countries in his sample of 18 countries. Yuan and Li (2000) came up with the same result for the US. In a cross-country study of 15 major industrial countries, Abrams (1999) found that the government expenditure ratio was positively related to the unemployment rate. Christopoulos and Tsionas (2002) examined the relationship between the government expenditure ratio and the unemployment rate for 10 European countries over the period 1961 to 1999 and found that there was unidirectional causality from government size to unemployment rate.

The magnitude of the government (un)employment effect is not trivial. Looking at a sample of OECD countries for 40 years, Algan, Cahuc, and Zylberberg (2002) found that the “creation of 100 public jobs may have eliminated about 150 private sector jobs”