[I spoke with Assistant Professor Lauren Cohen and, more briefly, with Assistant Professor Christopher Malloy of The Harvard Business School this morning and asked some questions about their recent, celebrated study on government spending and the response of the private sector. Here is a brief distillation of that conversation and a review of the work. My thanks to Lauren Cohen for editing this piece for accuracy and coherence.]

The great economist and Nobel Laureatte Freidrich A. Hayek once said: "the more the state 'plans' the more difficult planning becomes for the individual."

This insight, supported by mountains of economic data as well as by the sorry history of out-of-control state planning in the Twentieth Century could well serve as the mantra for the recent work by Lauren Cohen, Joshua Coval and Christopher Malloy of Harvard Business School entitled: "Do Powerful Politicians Cause Corporate Downsizing?" In the work, Cohen et al. examine the relation between powerful Committee Chairmanships in Congress and federal funding which gets directed to the corresponding states, and further, the impact of that locally targeted federal funding and the growth or downsizing of private sector businesses in the same regions. This unique empirical approach (specifically following exogenous shocks to federal spending related to well-defined positions of power in the U.S. Senate or the U.S. House of Representatives) allows them to quantify, in a way previously not considered, the ability of public spending to stimulate the private sector. The conclusion by Cohen et al. that government spending acts less to complement and more to crowd out private business is already having a profound impact on the public discourse regarding the multiple rounds of stimulus spending completed and planned by the Obama Administration. Given that the reigning ideology of happy government control has some of its roots in Obama's alma mater, Harvard Law School, as well as other institutions (the Kennedy School) at Harvard, it's fair to say that the Ivory Tower of Law and Politics is separated from the Real World of Business at Harvard just as it is in the rest of society; and the gulf is often wider than the Charles River.

The paper by Cohen et al. uses a 42 year baseline of data on the response of publicly held private companies (in terms of their capital expenditure, employment levels, sales and R&D) to the influx of federal money. This influx is quantified in terms of the changing of the chairmen of certain powerful Congressional Committees, which are ranked on seniority, as a result of elections, retirements, etc. and the consequent redistribution of earmarks from the home state of the previous chairman to the home state of the new chairman. The authors first demonstrate this fairly unremarkable claim that earmarks do indeed follow power in Washington and in particular committee chairmanship. The use of this metric is a key. According to Cohen, what they wanted to measure was an "exogenous" source of public funds, i.e. one that was not characterized by the interplay of private business and public spending. Looking at the money that moved from one state to another due to changes in committee chairmanship was like, according to Cohen, "having a helicopter dropping money here and there." More particularly, the helicopter drops the money in one state after having picked it up in another state.

The study is careful, scholarly and anything but flamboyant. The authors are careful to note that they do not currently include the effects on small businesses (such as restaurants) in their measure of economic activity, given the restricted access to this data by the Census Bureau (however, the authors have just been granted access, and plan to also study this important part of the economy). Limiting focus to publicly traded companies essentially ignores one kind of trickle-down effect. On the other hand, the government spending that they focus on is essentially "free money," that is, it is (on average) coming from one location to another and thus does not entail additional taxes which would necessarily accompany new spending initiatives. In addition, they do find large impacts in both large and small public firms. Overall, Cohen et al. conclude that, within the limits of their data, the "multiplier effect" of this kind of federal funding is between 0.6 and 0.7. This means that the economy benefits only 60-70 cents for every tax dollar spent.

The mechanisms for this effect are varied and include "structural crowding out," or direct competition between government and the private sector on the one hand, and more indirect influences such as the bidding-up of "factor prices" (for example the cost of labor) by government spending on the other hand. The study concedes that economic circumstances, such as the local employment rate, can mitigate the crowding-out effect of government. For example, if unemployment is high, the entry of a government enterprise has a weaker effect on the availability of workers for private enterprise. Cohen terms this effect the paper's "olive branch to Keynes."

Whatever the impact this study may or may not have on the spending orgy currently going on in Washington, it will not be ignored. The authors are scheduled to appear on C-SPAN to discuss their work next week. For those of us who view the proliferating legislative legacy of the Obama Administration as a Rube Goldberg nightmare of perverse incentives and mounting debt, Cohen et al.'s work provides ammunition for a counterattack. The Obama Administration has tried giving people money for worthless cars, extending grants to recover crab pots lost at sea in Oregon and funding the removal of graffiti from 100 miles of flood-control ditches in California. The claim has always been: "look, we stimulated the economy." The answer now is that all we actually got for our money were broken automobiles, rusty crab pots and (sparkling clean) concrete ditches. Some trade.