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.