Friday, July 8, 2011

08/07/2011: Effects of the spending stimulus on unemployment

An interesting study on the effectiveness of fiscal spending on unemployment was recently published in the CESifo working paper series. The full study can accessed here: Steinar Holden and Victoria Sparrman, "Do Government Purchases Affect Unemployment?" CESifo Working Paper No 3482, May 2011.

The study presents estimated effects of 1% increase in Government purchasing of goods and services on unemployment in 20 OECD countries for the period 1960-2007, controlling for a number of factors, including the size and the openness of the economy, the exchange rate regime and the economy position in the business cycle.

To summarize relevant results (found in Table 7) in the case of small open economies within the currency union, the effect of 1% increase in government purchases of goods and services translates into 0.37 decrease in unemployment rate. The effect can be as high as 0.47% decrease. Year after there is no net effect of jobs creation from the purchasing.

So what does this mean in the case of Ireland? Per latest QNA, Irish GDP in current market prices was €155,992 million in 2010. 1% of that spent on new purchases of goods and services amounts to €1,559,920,000. Q1 2011 unemployment, per QNHS, amounted to 295,700 and the unemployment rate stood at 14.1%. These are our inputs into the estimate.

Now, let's make an assumption concerning jobs created - suppose these pay €35,000 per annum in wages. Suppose that they pay €7,067 in income-related taxes (inclusive of USC etc), as consistent with single tax filer with no deductions. Suppose the social welfare benefits savings amount to €350 per week (note these are taken on purpose to be larger to account for other benefits that might be foregone) to the annual total of €18,200. Suppose that additional 30% is collected on income tax contributions due to higher consumption taxes contributions in employment - generating savings of additional €2,120 per annum.

So total savings per person moved off welfare into employment are roughly speaking €27,287. In other words, we assume that for each €35,000 job created, the Government get back almost €28,000 through various tax returns and savings.

Now on to the estimated impact of 1% increase in Government purchases of goods and services:
  1. Case 1: maximum effect of 0.47% reduction in unemployment rate will result in 9,857 jobs created with the total cost of €158,260 per job created. Net of Government returns and savings, this means net cost per each job created of €130,873. Total impact is to generate a loss of 0.84% of GDP due to 'stimulus'. If we are to assume that all of the jobs created remain for ever after the 'stimulus' (a very tall assumption, but let's be generous), while the Government finances the stimulus at a constant interest rate of 6%, it will take almost 7 years for the economy to recover the costs of the 'stimulus' (if the rate of borrowing is zero - e.g. by using NPRF or some other 'free' funding, the period to recovery shrinks to 5.8 years).
  2. Case 2: most likely effect of 0.37% reduction in unemployment rate will result in 7,760 jobs created with the total cost of €201,033 per job created. Net of Government returns and savings, this means net cost per each job created of €173,646. Total impact is to generate a loss of 0.88% of GDP due to 'stimulus'. If we are to assume that all of the jobs created remain for ever after the 'stimulus', while the Government finances the stimulus at a constant interest rate of 6%, it will take over 9 years for the economy to recover the costs of the 'stimulus' (if the rate of borrowing is zero, the period to recovery shrinks to 7.3 years).
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