10.28.2012 14

Government spending’s misleading impact on GDP

Our National DebtBy Bill Wilson — On Oct. 26, the Bureau of Economic Analysis’ advance estimate of the Gross Domestic Product (GDP) in the 3rd quarter (Q3) of 2012 showed 2 percent growth — not really a good number.

Just to get to the 3 percent annual growth rate the Obama Administration had originally forecast at the beginning of the year, the economy would have to grow at an annualized pace of 6.7 percent in the fourth quarter — something not likely to happen.

In fact, the numbers look even worse upon examining the fine print, because 20 percent of the nominal increase in GDP was attributable to increased government spending. If government spending had held steady, as it had the prior two quarters, growth would have only come in at a reported 1.6 percent.

That result prompted a study at Americans for Limited Government into what would happen if one takes government spending out of the equation entirely and then calculates the growth rate of the private sector alone.

The study shows annualized growth of the GDP versus that of the private sector with government spending removed as a component. So for example in Q1 2012, the GDP grew by 2 percent, but the private sector grew by 2.9 percent. But in Q3, the GDP grew by 2 percent but the private sector only by 1.96 percent. Why?

Because when government spending is included as a component of GDP, and then is held steady or cut, as in Q1, it weighs down the GDP on a nominal basis.  And when spending increases, as it did in Q3, it boosts the GDP nominally speaking. This is an inherent bias of the first order in favor of government expenditures when measuring the health of the economy.

The implication of this finding is that one will often not get a good GDP number without dramatically increasing government spending. Moreover, if one physically cuts spending substantially, the Bureau will measure a marked decrease in the GDP. That is, unless the decrease in government spending is offset by an even larger increase of the private sector.

This type of reporting system makes it difficult to chart the effects of governmental policies, particularly expenditures, on the private sector by a mere casual reading of the GDP. It is therefore misleading.

More importantly, it creates a disincentive against legislators ever cutting spending, even if our fiscal house is crumbling, as it is today, because it will cause a technical recession.

Say we had balanced the budget in Q1 2012 with spending cuts. One would distribute the actual $1.2 trillion deficit for the year throughout each of the following four quarters, resulting in $300 billion less in government consumption expenditures and investment in each quarter. This is a rough estimate because oftentimes appropriations stretch out over several years.  But, for the sake of simplicity, let’s assume $300 billion less spending per quarter.

Assuming no immediate impact on private consumption, the GDP in Q1 2012 would have come in at $15,178.3 billion, a nominal decrease of $142.7 billion. Converted into real GDP, the economy would have contracted by a reported annualized rate of 4.2 percent.

If one assumes an immediate one-to-one impact on private consumption and investment, the GDP in Q1 2012 would have come in at $14878.3 billion, a nominal decrease of $442.7 billion. Then the reported rate of contraction would rise to 12 percent in terms of real GDP.

What would actually happen is probably somewhere in between a reported 4.2 and 12 percent reduction of GDP immediately.

Suffice to say, there would likely be at least two quarters of negative growth resulting from spending cuts of that magnitude — and that’s probably on the low end, considering what happened after World War II. Then, the economy “contracted” by 1.1 percent in 1945, by a whopping 10.9 percent 1946, and then again in 1947 by 0.9 percent.

But was the economy really contracting? Or was spending simply decreasing?

All of this underscores why government spending should probably not be included as a component of the GDP — it is a misleading indicator of true economic health. But even more so, it emphasizes why we need a real private sector recovery in this economy.

Especially when one considers the composition of our workforce.

Only 22 million Americans work for government at the federal, state, and local level, just 15 percent of the 143 million people who have jobs.  Yet close to 23 million Americans cannot find full-time work in this economy, and another 5 million have given up looking.

There will be no recovery from this depression without a robustly growing private sector, because we cannot all work for the government. We need to grow the real economy, and going forward, the public will need useful metrics that do not double-count the impact of government spending on economic output.

Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.

  • Dorisc

    Wasnt everyone made aware?Thats how he messes with all the numbers, even those we think are non political. Nothing in Washington is non-political

  • pduffy

    If you believe you can get fat from eating your own flesh, then you can believe that government spending ‘boosts’ the economy. Every cent that the government ‘spends’ was stolen from the private sector.

  • reggiec

    The brutally honest truth is that government has grown to the point that the productive, private sector, wealth creating portion of society can no longer support it.

  • Bendix

    The problem with this article is the same problem at the heart of a lot of conservative economics today.

    Government spending is part of the economy. If you fire a school teacher that teacher will no longer have a paycheck to spend at the store. The teacher might default on their mortgage. The economy would shrink in the short-term.

    Conservatives can say that the government spends money in stupid ways that provides little or no long term value. We can have that discussion. You can also argue that balancing a budget helps grow the economy in the long-term.

    But it makes no sense to say that you can cut spending today and fire a lot of teachers and bureaucrats today and not feel the economy immediately shrink.

  • jwatersphd

    This seems quite obvious, so you have to wonder why the tea party and chamber of commerce ideologues don’t get it. Of course they do when we talk about defense cuts. The notion seems to be that having a justice system, inspecting food and drugs, sponsoring research, building roads and bridges, delivering the mail, and having teachers and schools are all “frills” or worse that we can easily do without, but, guess what? They aren’t. I’m sure they’d like it all turned over to the private sector. Would we really like to have the Bank of America police force? The Halliburton court system? The Blackwater food and drug inspection service? Goldman Sachs National Park? Might be good for the 1%; I think that’s the main idea.

  • The Frog Prince

    Since welfare now accounts for over a trillion dollars spent annually your theories get holes shot right through them.

  • jwatersphd

    What has the size of welfare got to do with the fact that we do need some public services, and the people who provide them have jobs and an income, which they spend on things other people make? Would my “theories” be intact if there was less spending on welfare? What’s your point?

  • topeka

    Some of us cannot work for love, money, or sacrificing our first born … so why should we support those parasites?

  • topeka

    piled higher and deeper,

    if you had an education, you could answer the question.

    why is it you are so stupid that fail to see the benefit of cutting the jobs of those who destroy jobs?


  • topeka


    We cannot have that discussion, because that discussion is not on the table.

    Why should we destroy jobs that support teachers, and continue putting the teachers’ salaries on the nation’s / states’ credit cards?

    The government is already beginning to shed jobs, and it will continue to do so until the goose the govt continues to cook is removed from the oven and allowed to recover.

  • topeka

    pduffy, exactly

  • WhiteFalcon

    People think that Government spending and Government jobs are good for the economy, but they are wrong. Government spending is always very ineffcient and wasteful which means that they always spend more on any job than private industry would. Government jubs are the same thing. The Government always takes much more from the people in taxes than they put into pay for Government workers. That is why you frequently see things like the Government spending say $200,000 for each $50,000 job that they create. All that graft and corruption in the Government along with the more or less honest inefficiency adds up to complete lunacy. Government jobs are a big net negative on the economy. Government spending is a net negative on the economy. When you get down to it, although some Government is required, basically Government is a net negative on the economy, period. The more you can get Government out of the economy the better off the economy will be.

  • WhiteFalcon

    The Government shouldn’t be paying teachers at all. That is for local school boards to do.Federal Government should be out of education totally except to direct our money where it is needed without strings attached. Aside from that, setting basic standards that schools should strive to exceed is all they should be doing. There should be no Government Teacher’s Union. Ever since the Federal Government has stuck its ugly nose into education, education has gotten worse and worse, and it doesn’t matter how much money you pump into the system, as long as there is no incentive to improve, like there is now, there will be no improvement. Quite the opposite will be seen. When you have a tenure system, things get worse and worse, which is what we have been seeing the past sixty years or so.

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