Europe Shows Government Spending Fails to Stimulate Hiring

Published June 6, 2013

The recent economic performance in Europe casts doubt on the assumption that government can alleviate downturns in economic activity by spending large amounts of taxpayer money that will stimulate employment. Those nations that have made free-market reforms and have imposed government spending cuts, such as Germany, France, and England, are faring much better than those, such as Italy, Greece, and Spain, that still struggle under Keynesian and socialist ideas of centralized planning and deficit spending.

A cursory analysis of OECD data confirms this contention. I found the requisite statistical data for the 30 nations listed in Table 1. (See table Table 1) The first regression, listed in Table 2, runs 2007 government expenditures (as a percentage of GDP) as the independent variable against 2007 unemployment rates for the 30 nations. (See table Table 2) (Note: data prior to 2008, and the economic upheaval the financial crisis caused, was used.)

In statistical terms, there is a positive slope parameter of .041 but the p-Value of .4833 shows that it is statistically insignificant. However, this regression does not prove cause and effect, for if we reversed the regression and used the unemployment rate as the independent variable we would also get a positive slope parameter, with a p-Value of .4833.

Unemployment Causes and Effects

Many economists and policy advocates argue increased unemployment rates drive higher government spending. That is, higher unemployment rates necessitate that governments spend more on their welfare programs. Others argue that higher (and more inefficient) government spending drives up unemployment rates. 

To determine whether we can ascertain a cause-and-effect relationship, the next two regressions in Table 2 use lagged data. The first of these regressions uses 2005 government expenditures (again, as a percentage of GDP) as the independent variable against 2007 unemployment rates. Again, a positive slope parameter is found but it is also statistically insignificant with a p-Value of .3566.

Interestingly though, this p-Value is lower (signifying a higher level of statistical confidence) than the p-Value found when running 2005 unemployment rates as the independent variable against 2007 government expenditures. This suggests there is greater support for higher government spending causing higher unemployment rates than for higher unemployment rates causing higher government spending.

Higher Spending, More Unemployment

To determine whether dynamic influences had any impact, the next two regressions were run. That is, did a nation with a large government sector but that has undertaken austerity measures but still has a large government sector relative to other nations in the study find its unemployment rate falling or rising? Here, the findings indicate increasing government spending (as a percentage of GDP) will increase the nation’s unemployment rate.

The first of these two regressions uses changes in government expenditures from 2000 to 2005 as the independent variable against changes in the unemployment rates from 2000 to 2007. Here a positive slope parameter of 0.35 was found with a p-Value of .0017. This implies that a one percentage point increase in government spending (as a percentage of GDP) from 2000 to 2005 will increase the nation’s unemployment rate by 0.35 percentage points by 2007. And we can be 99.83 percent confident that there is a positive relationship.

For instance, if a nation’s government spends 40 percent of GDP in 2000 with an unemployment rate of 6.0 percent, then an increase in the government sector to 41 percent of GDP in 2005 will increase the unemployment rate to 6.35 percent in 2007. When the regression is reversed, a positive slope parameter is found but the p-Value is now .4093. That is, when the changes in a nation’s unemployment rate from 2000 to 2005 are used as the independent variable against the changes in government expenditures from 2000 to 2007, a slope parameter of .42 is found but only a statistical confidence of 59.07 percent can be attached to it.

Importance of Entrepreneurs

Statistical analyses can never prove a hypothesis conclusively. Many statistical analyses have shown a positive correlation between government spending and unemployment rates. But Keynesians have always contended the cause-and-effect are that higher unemployment rates have resulted in governments subsequently increasing their spending. But these last two regressions give greater statistical support to the view that higher government spending results in higher unemployment rates. Therefore, it is unlikely that government stimulus programs can stimulate employment.

Governments must realize that true job creation results from private sector entrepreneurs assessing the needs of consumers and then creating firms, and in the process productive and sustainable jobs, to meet these demands. The optimal government policy to foster job creation is to keep to the minimum taxes, especially marginal tax rates; regulations; and overall government involvement in the private sector. Historically, nations that have done this have been engines of economic growth and job creation.

Mark Ahlseen ([email protected]is associate professor of economics at Shorter University in Rome, Georgia.