Pethokoukis, Economics, Taxes and Spending

US needs more private-sector growth, not GDP accounting tricks

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Simon Kuznets, the economist who created the accounting mechanism known as gross domestic product, warned that “distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.”

That quote casts an interesting light on new analysis by The New York Times which concludes “the drop in government’s contribution to economic growth is the largest in more than 50 years.” Now, that conclusion is correct — if your analysis of economic growth begins and ends with an examination of the components that constitute gross domestic product statistics. The past two years, for instance, saw the private sector bits of GDP rise and the public sector ones fall. But that’s not the whole story.

GDP is an accounting artifact that may or may not reflect economic reality, as Kuznets well knew, particularly when it comes to valuing government spending. As economist Tyler Cowen points out in The Great Stagnation, when government spends $1, government statisticians value its contribution to GDP as $1 — at cost — rather “than being able to measure prices set in a competitive market.” GDP values $1 spent by government on Solyndra, cancer research, an aircraft carrier, or an analysis of exotic ants as being equivalent to each other, the previous dollars that were spent — and to investment in a new semiconductor manufacturing plant by Intel.

Theoretically, GDP growth that was all government spending is no different than GDP growth entirely driven by the private sector. But is it really? An example: In 1983, GDP rose by 4.5%, with 0.8 percentage point of that coming from direct government spending. (Recall the big military buildup.) In 1997, GDP also rose by 4.5%, but just 0.3% came from government spending. Which was the healthier economy?

In the short run, the sequester — even if smartly managed to spare valuable, pro-growth public good spending such as basic research — would by definition lower GDP to some extent, as well as cost government jobs. But over the longer-term, more of our national economic resources and talent would be diverted to the more productive private sector where market forces would direct them to higher value uses. The result would be a stronger economy. The same goes for government distortions of the private sector such as subsidies which lead to megabanks. Do we really want our top scientists cooking up arcane financial derivatives and trading algorithms?

Look, government spending as a share of GDP has fallen by roughly a percentage point since 2009. Yet the past two years, nominal private-sector GDP rose by 5% a year. And remember the 1990s. Government spending fell from 22.3% of GDP in 1991 to 18.2% in 2000. Yet the economy grew at a 4% average annual rate. The goal of government policy should be to help grow the private sector, not grow government to inflate GDP statistics.

5 thoughts on “US needs more private-sector growth, not GDP accounting tricks

  1. Actually government expenditures distort GDP even more than this. To see why consider this hypothetical. Consider a country with a $1 trillion private (personal expenditures and investment) GDP and no government spending (if we were only so lucky). Now suppose the government decides to spend $1 trillion on widgets. Widgets are totally useless and have no value. They decide to pay for the widgets by printing $1 trillion in new money. What has happened? Real GDP hasn’t changed (the widgets are worthless), nominal GDP will be $2 trillion but inflation should be about 100% (since we doubled the money supply). This means the GDP price deflator (roughly the CPI) should also be around 100%. Thus our final “real” GDP figures would be $500 billion for the private economy and $500 billion for the government. The total is correct but it overstates the government contribution and understates the private. In other words, useless government purchases (e.g. bridges to nowhere) never get accounted for properly

    • that is a good point, well articulated.

      now I do wonder how you’d compare a country that spends more than 50% of it’s available revenues on National Defense vs the rest of the world that spends so much less than the next 10 countries COMBINED STILL spend less money.

      how much is National Defense actually “worth” when described as “widgets”?

      Here’s the National Defense expenditures for the US:

      National Security Outlays in Fiscal Year 2009
      (billions of dollars)

      Department of Defense 636.5
      Department of Energy (nuclear weapons & environ. cleanup) 16.7
      Department of State (plus intern. assistance) 36.3
      Department of Veterans Affairs 95.5
      Department of Homeland Security 51.7
      Department of the Treasury (for Military Retirement Fund) 54.9
      National Aeronautics & Space Administration (1/2 of total) 9.6
      Net interest attributable to past debt-financed defense outlays 126.3
      Total 1,027.5

      our total corporate and income tax revenues are about 1.3T.

      • Interesting choice of defense and 2009. Let’s add in the whole thing for 2008, last full year of Bush’s term, and 2012, the last full year of Obama’s term, not just defense (in billions):
        Last Bush Yr Last Obama Yr
        2008 2012 % Change
        Defense $730.70 $902.20 23%
        Pensions $659.80 $819.70 24%
        Health Care $671.40 $846.10 26%
        Welfare $322.30 $451.90 40%
        Interest on Treasury Debt $451.10 $450.30 0%
        Deficit $458.60 $1,327 189%
        Gross Public Debt $9,986.10 $16,350 64%

        Defense is a large part but if you completely eliminate ALL defense spending, you would still run a $400 + billion deficit for the 5 minutes it would take for us to be invaded.

        • totally agree. you can’t get there by only cutting Defense nor entitlements and in fact, you cannot get there by cutting them both unless you want to cut both by 1/3 to 1/2 – because tax revenues have shrunk so much since the economy tanked.

          but then again.. we spent 1/2 of what we do now for defense in 2000 and had a balanced budget and did not suffer any invasions though we did suffer attacks.

          we don’t seem to be able to decide how much we ought to be spending on Defense … and that leads to bad stuff – like doubling spending and ending up with a intractable deficit.

          I would think that 50% of our available revenues would be a reasonable goal.

          and if we think 50% of 1.3 Trillion is not enough then we need to be thinking about putting more money on it.

          but what we can’t do is spend 1T on Defense and take in 1.3T in taxes. That won’t work.

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