What does it really mean
to create a job?

Energy Entrepreneurs, a clean energy advocacy group, recently announced that in the first quarter of 2013, 12,000 clean energy jobs were created in the United States. By and large, these investments were made as a result of subsidies, whether that means government spending, tax credits, or loan guarantees. But what does it mean when we say that jobs were created?

There is a great deal of public confusion regarding how government spending can create jobs. Politicians take advantage of this by greatly overstating the number of jobs that a project could potentially create. Few know that the most theoretically sound mechanism by which government spending could create jobs is via deficit finance. In other words, you must increase public debt if you want to use the government to create jobs.

While at times the American public has believed it to be worthwhile to allow the Federal government to engage in deficit finance in order to create jobs, this is not nearly as true for state and local governments, which face much harsher constraints when borrowing money.

Now, to be clear, there are some projects that may make sense regardless how high unemployment is. It may make sense for the government to spend on infrastructure, for instance. But that rests on the economic benefits outweighing the costs of such a project, not how many jobs it will create. Cost-benefit analyses which emphasize job creation miss the point. Paying people to dig holes would ???create??? just as many jobs as the infrastructure project with the same amount of money. If you advocate a particular project, you should demonstrate that the project is a wise use of the money, not because it created jobs via increased government spending.

But why are government spending and deficits special? Well, the idea that drives economists??? theorizing very rarely enters the public discourse. Basically, when prices in the economy are stagnant or falling, the labor market seizes up. It becomes much easier for workers and employers to come to employment agreements when prices move slowly and steadily upwards. To grasp the intuition for why this may be true, imagine how it feels when an employer asks you to take a pay cut. If prices overall are stagnant or falling, employers would need to often ask their employees to take such a cut. Rising overall prices mitigates this problem.

It is the responsibility of the Federal Reserve to keep unemployment low and inflation tamed to bearable levels. It can push money out or remove it from the system to reach the optimal inflation rate ??? this is what is actually happening when you hear that it ???lowers??? or ???raises??? interest rates. If unemployment is too high, it pushes money into the system until the Fed hits the interest rate it believes will lead to the best mix of inflation and unemployment for the economy.

Many economists believe there are limits to what printing money can do when interest rates get too low. To force spending into the economy when in a severe slump, it is believed that borrowing money just to spend it can also increase inflation. According to a recent review of the academic literature by Valerie Ramey of UC San Diego, increasing the deficit by a dollar may increase spending overall in the economy anywhere from $0.80 to $1.50. In doing so, the government could force more inflation into the economy and thereby increase employment- assuming a lack of inflation is in fact the problem.

When advocates like Energy Entrepreneurs announce new projects that promise tens of thousands of new jobs, they typically ignore this. If the projects employ 12,000 people, they claim 12,000 jobs are created, even if those people would have held jobs elsewhere. But the effects on employment very much have to do with how the project is financed, and its subsequent effect on inflation. If the project is financed with debt, you might get more jobs by more spending and more inflation, as each dollar borrowed increases spending by $0.80-$1.50. If the project is not financed by debt, and instead is financed via tax dollars or spending cuts elsewhere, there may be no effect at all on spending, inflation, and employment.

Moreover, the Federal government can always bail itself out by printing money to buy its own debt if it borrows too much. States and local governments don???t have that option. If they engage in borrowing too much, they face the very real risk of going bankrupt. This is what is happening to Greece right now.

So, who still believes it is a good idea for states to create jobs this way?

Ryan Murphy is an adjunct economist at the Beacon Hill Institute.