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Business model doesn't work in government

Some recently elected politicians seem wedded to an economic model that kills jobs rather than creates them. Their approach to stimulating private sector employment is to shrink the size of state government, which sounds like a good idea. But the unintended consequence of this flawed approach is quite the opposite.

The new governors of Florida, New Jersey, Ohio and Wisconsin are among the most visible proponents of this misguided economic policy, including their highly publicized refusal to accept federal dollars for infrastructure investment, even though that investment would have had an employment boost during the recession and produced long-lived capital assets in their states.

Republican forecasters at Goldman Sachs and Moody's Analytics (headed by Mark Zandi, John McCain's economic adviser in 2008) warn that the impact of the states' actions would result in an economic contraction that would push the national economy in the wrong policy direction — a push that would potentially result in a loss of 700,000 jobs.

Not a business

The frequent lament is that government is not run like a business; "if only government adhered to business principles, the United States would be solvent, more efficient, and more prosperous." As with all trivializations in economics, this one resonates well with the public. But it is dangerously wrong. Along with this misconception goes its corollary: Private sector CEOs are "job creators" and governments are "job killers" whenever they impose business taxes.

The reality is that it takes a great confluence of inputs to create jobs. Job creation requires coordination of both the public and private sector. Public goods (roads, schools, universities, courts and law enforcement) paid for with taxes are essential components of successful job creation efforts. The private sector firm is simply the necessary, but not sufficient, site of most of these created jobs. No matter how much CEOs claim to be self-made success stories, their success, as well as the success of the jobs they "create," is the product of inputs from both the private and public sector.

The role of government

The economy is not some large version of a business firm. Managing an economy requires a different economic model than the one followed in managing a firm. CEOs employ microeconomic reasoning to guide all aspects of their financing, marketing and operating decisions. It is natural for firms to reduce their activity in recessions. The reason is simple: They have a range of products and services to sell and due to the recession the demand for these products and services is reduced. They have a strong incentive to contract, and they don't understand why the government does not follow the business example and contract as well.

By contrast, managing an economy requires an understanding of macroeconomics, which focuses on the aggregate behavior of firms in the economy. Economic activity encompasses four categories of spending: consumption, private sector investment, net exports and government. In this recession, the first three of these declined. If the government had tightened its belt, as per the policies espoused by the governors above, Zandi estimates that unemployment would have risen to 15 percent, rather than stalling at the still-terrible rate of 9.5 percent.

Those who understand macroeconomics know that the government has a different role in the economy than does the individual firm. A properly run government will counter the business cycle — dampening an expansion to control inflation and softening a downturn to limit unemployment. A properly run business firm, even a very large one, cannot hope to counter the business cycle and must accept its limited role within it.

Job killers

Today, fiscally wise governors, who understand this countercyclical nature of government expenditures, would work to increase their spending — not contract it. Certainly, they would not be rejecting a federal infusion of funds into their budgets. By creating jobs that are badly needed during the recession, their actions would help alleviate the economic hardship of their citizenry and enable the recovery to come sooner and be more robust. Their failure to do otherwise is a job-killer, both in the short run and the long run.

Here is the key: Spending must include public sector infrastructure investments. Public expenditures, during a recession, on projects such as bridge, road and freight track repairs would create jobs at a time when spending from the private sector is contracting. Such expenditures would also provide capital assets that would enable the economy to expand in a more robust fashion when the recovery comes.

We can hardly anticipate that some future recovery will be robust as long as our cities suffer with potholes, car-swallowing sinkholes and water-main ruptures, and while our rail systems encounter frequent derailment and slow transit of time-sensitive freight due to poor track conditions. The time to fix these problems is during the recession rather than when the expansion is placing increased demands on neglected infrastructure.

Charles O. Kroncke is associate dean in the University of South Florida College of Business. William L. Holahan chairs the department of economics at the University of Wisconsin-Milwaukee.

Business model doesn't work in government 03/27/11 [Last modified: Sunday, March 27, 2011 5:30am]

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