3rd Quarter GDP Growth Due to Government Spending, No Reason to Celebrate

As the White House celebrates "the thirteenth straight quarter of positive growth" in GDP (gross domestic product, or the amount of goods and services produced in the country), Reason columnist and Mercatus Center economist Veronique de Rugy charts the numbers to reveal some deeper truth: The "unexpectedly" high initial estimate of 2 percent growth in GDP is mostly due to government spending. Without a bump up in public-sector largess, economic growth would be flat compared with the second quarter. Indeed, total private sector growth lost one-tenth of a percentage point. 

It's a bizarre artifact that GDP figures count government spending, so that if government increases spending by a dollar (whether by raising taxes or taking on more debt or simply printing more money), GDP increases by a dollar. Which is one of the reasons why GDP doesn't necessarily match what most of us would consider the real economy. And it's also why Keynesians always point out that cutting government reduces GDP. That's technically true, after all, even as it tells you very little about whether things are moving in the right direction in a self-sustaining way.

Alan B. Krueger, head of Obama's Council of Economic Advisers, notes that state and level government "purchases were essentially unchanged" but that federal expenditures were up (especially on defense, which jacked 13 percent in the third quarter).

An economy that's dependent on government spending for increases in growth isn't a good thing (you gotta pay for that spending someday, and much of the spending is simply poorly allocated as students of specific stimulus recipients can tell you).

As de Rugy and others (such as Reason's Shikha Dalmia) have shown that public-sector spending crowds out private-sector spending and investment pretty quickly. So it's not just that the government is sucking money out of the economy via taxes or debt to spend in the first place, but that such spending causes private actors to retrench.

That's especially true when it comes to defense spending, which the economist Robert Barro argues has a multiplier of just 0.8 - meaning that every dollar of government spending on defense nets just 80 cents in overall GDP growth. You just can't make up that sort of loss on volume, no matter how many dollars you spend. [Note: as reader Rob Coffey notes in the comments section, Barro believes that defense spending has a bigger payoff than other forms of government spending.]

For those who worry that cutting government spending by definition means that the economy will crater, check out economist Arnold Kling's analysis of what happened to the U.S. economy when government spending shrunk by two-thirds between 1945 and 1947. Far from dropping off a cliff, GDP increased by about 10 percent. More recently, countries such as Canada and New Zealand that have cut government spending have also seen the economy grow.

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  • robc||

    2% is never a reason to celebrate. Even ignoring the government spending factor.

  • tagtann||

    Well know that makes a whole lot of sense dude. WOw.
    www.Anon-Yes.tk

  • robc||

    That's especially true when it comes to defense spending, which the economist Robert Barro argues has a multiplier of just 0.8 - meaning that every dollar of government spending on defense nets just 80 cents in overall GDP growth.

    You got that backwards. For defense spending it is less true. Barro shows that for non-defense spending, the multiplier is approximately 0.

    Defense spending reduces overall GDP growth LESS than non-defense spending.

  • Red Rocks Rockin||

    Probably not a coincidence, then, that during the "high-tax, roaring economy" 1950s and 60s Tony's always crowing about, defense spending was roughly half of the total federal budget.

    We still need to cut it, though.

  • ||

    Wouldn't the multiplier be 1, not 0? I know what you mean of course, but still.

  • Lord Humungus||

    so they should have spent moar moar moar!

    The Lost Decade? or the Lost Generation?

  • The Craig||

    Just wait until Q4, go Sandy go!

  • db||

    There's something fundamentally wrong with a economic metric that counts tax money and debt redirected and spent on government projects as part of anybody's "product."

  • R C Dean||

    The tax money I can see; if the feds hadn't taken and spent it, the taxpayer would have, so that's a wash (not counting the opportunity cost, of course).

    Government debt, though, should be netted out of GDP.

  • db||

    The tax money is really just diverted though; you can't necessarily say a taxpayer would have spent it. But since the entire US economy seems to be based on discouraging savings, I can see how you might think that.

  • robc||

    GDP = C + I + G + (X - M)

    Without the tax the money would have either gone into C (consuption) or I (investment).

  • sarcasmic||

    That whole (X - M) is misleading as well.

    Who's to say that those dollars that went out to purchase M don't come back as foreign I?

  • robc||

    Of course.

    The whole equation is bullshit.

  • sarcasmic||

    Macroeconomics is bullshit.

  • db||

    As I wrote, there is something fundamentally flawed here.

  • robc||

    For proles, purchases count in GDP whether we use earned money or borrow.

    However, money borrowed from outside the US, whether public or private, should probably be netted out.

    If we borrow the money from China, then count it in China's GDP, not the US.

  • Bill Woolsey||

    No it shouldn't.

    GDP measures the production of goods and services in the U.S.

    I have no idea what you would be trying to measure if you subtracted off borrowing from foreigners from the output of goods and services.

    Imported goods and services don't count as output and exported goods and services do do. A trade deficit is matched by a net capital inflow, which includes things like borrowing from foreigners.

    I don't think deficits and a national debt are good things, but trying to adjust the measure of output to suggest that some of the output isn't really output is a mistake.

  • R C Dean||

    For the fiscal year ending 09/30/12, GDP increased about $800BB. The deficit was between $1100 - 1200BB. Net of federal borrowing, GDP decreased by $300-400BB in FY 2012.

    Some recovery.

  • Red Rocks Rockin||

    Deficit last year was $1.27 trillion, according to the Treasury.

  • R C Dean||

    What's a few billion among friends?

  • Bill Woolsey||

    This is confused.

    It is really output now, even if the government goes into debt.

  • Red Rocks Rockin||

    The problem isn't the "output"--it's the long-term mathematical implications of running deficits that are 8% of GDP while the so-called "real" GDP is growing only 2%.

    Anyone capable of doing an exponential function can see what happens to that over time.

  • Drake||

    Waiting for a troll to defend the glorious New Deal...

  • robc||

    Hey Nick, posting my full name is NOT COOL.

    Not that I care, but NOT COOL.

  • Lord Humungus||

    you were outed?

    any relation to the hockey player?

  • robc||

    Nope.

  • Red Rocks Rockin||

    For those who worry that cutting government spending by definition means that the economy will crater, check out economist Arnold Kling's analysis of what happened to the U.S. economy when government spending shrunk by two-thirds between 1945 and 1947.

    The main concern right now is that just to get even, you're going to have to be willing to take that initial 8% or so drop, and keep hammering to the public that not taking on more debt is a GOOD thing until the economy begins picking up again. It also means neutering any further QE efforts and letting banks who are over-leveraged take their medicine and go under. It's not easy for a President to get elected by saying, "The first 2-3 years, it's going to be tough, but it's necessary to get the bad debt out of this system and start fresh."

  • Whiterun Guard||

    Only way to do it would be to promise all the normal crap, and then do that after you're elected. Since no one pays attention to whether or not you break every single campaign promise you've ever made.

    Of course that would depend on someone running that actually cared about the country AND was bright enough to realize it. I'm not optimistic.

  • The Late P Brooks||

    it's also why Keynesians always point out that cutting government reduces GDP.

    Yes, which is why Keynesians are always and everywhere morons.

  • The Late P Brooks||

    So it's not just that the government is sucking money out of the economy via taxes or debt to spend in the first place, but that such spending causes private actors to retrench.

    I was talking to one of my lefty friends the other day, and when I made some offhand comment about inflation, he told me there is no inflation. He's one of those guys who think deflation is our real worry. I suspect he was ready with the next talking point about wage stagnation as "proof" there can simply be no inflation. He at least knows enough to mention velocity as an explanation for why the massive increase in the money supply hasn't yet brought about inflation. He's a pretty good guy, and I didn't want to get in a big argument with him, but I really wanted to ask him what could possibly be causing people/businesses/banks to be sitting on so much cash.

    Actually, thinking about it later in general terms, it occurs to me that there is a lot of government-induced inflation caused by back door inflows of subsidies like food stamps and ethanol, in much the same way that government subsidies are causing inflation in higher education.

  • The Late P Brooks||

    it occurs to me that there is a lot of government-induced inflation caused by back door inflows of subsidies

    By which I mean the *mechanism* by which the price rises which nobody who buys his own groceries can pretend are not real are brought about.

  • Bill Woolsey||

    That most of the increase in production was supposedly military goods and services -- soldiers or tanks and missles -- is not a good sign for private sector recovery.

    However, the notion that real GDP should not count tanks and missles and the services of soldiers as output of the economy is confused.

    Now, if you count all of that as improving human well-being in the same sense as more and better food or more and better cars, then that also is confused.

    But it is stuff that was actually produced. It is generally valued at cost, which means that it is being counted as the private consumer goods that could have been produced instead. In my view, that is a sensible way to do it.

    In the original post, and especially in the discussion, there was a rapid drop in to confusion. The government output is really there now regardless of how it is financed.

  • Red Rocks Rockin||

    But it is stuff that was actually produced.

    This is just question-begging. G isn't just made of up tanks and missiles being built, or soldiers being trained (a specious argument to be sure, considering how low-manned and low-equipped our forces are these days), it's counting "all" government spending. You can't seriously be arguing that this is producing goods and services, unless you are claiming that every penny of Social Security is being sunk back into the economy.

  • ant1sthenes||

    It's producing bureaucracy. GDP is agnostic as to whether what is produced is actually useful.

  • AZ||

    Bill, you're confused about the nature of the argument. Correct textbook calculation of GDP should of course include G.

    The argument was, and is, that GDP is a terrible metric for measuring a sustainable economy or making projections about the state of the economy going forwards, and attempts to correct that to a more useful measure.

    C = people getting what they are willing to pay for
    I = preparing to give people stuff they will actually pay for
    G = stuff people aren't willing to buy on their own, and the infrastructure to restrict future I and C

    These are all different things, with different future impacts on the health of the economy. Just because they're all denominated in dollars and can be classified as "production" doesn't mean that they can be freely aggregated to a truly useful metric, and that's why we're going back and forth about ways to correct it.

  • The Late P Brooks||

    The government output is really there now regardless of how it is financed.

    That's nice. Except the actual point is that government spending is counted as GDP no matter whether it does anything productive or not. Paying people to dig holes, while another crew follows them around filling the holes back in is not productive. Paying more firemen to sit around the station house scratching their asses is not productive; especially when the government borrows the money to do it.

    "Spending" not same as "investment".

  • robc||

    A better example would be taking all of those tanks and missiles and dumping them in the ocean.

    According to Bill, that counts as production, according to me, nothing is produced.

    Same for dropping them in Iraq instead of the ocean.

  • robc||

    Bill is making a less obvious broken window fallacy.

  • ant1sthenes||

    Would it less wasteful if a billionaire was paying for that, just to wallow in the futility of it?

  • T o n y||

    you gotta pay for that spending someday

    Not according to libertarians or anyone who's signed Grover Norquist's pledge.

    Tax hikes are always on theoretical children and grandchildren it seems, never to pay for what the people are currently buying.

  • ||

    Not according to libertarians or anyone who's signed Grover Norquist's pledge.

    [citation needed]

    I forgot that libertarians and Grover Norquist said spending never needs to be paid for! Gee golly, how could we have forgotten THAT ONE? Maybe because no one ever said it.

  • ||

    Oh, except for the fact that libertarians don't actually want to buy what "the people" are currently "buying"demanding.

    You really don't get it at all, do you?

    Also, last I checked Grover Norquist is a Republican not a libertarian.

  • ||

    IOW, there's no buying involved, since there is no price being paid.

    People demanding their free stuff are doing no more than demanding things at other people's expense through the utterly cost free and risk free act of voting.

    And that's why so many libertarians think democracy is no more than a chance for one group of people to choose another group of people to commit armed robbery on their behalf.

    That's the difference between me and you, Toady. You are willing to kill people over a lot more things than we are.

  • شات عراقنا||

    thanks

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