Another big decline in US government spending took its toll on first-quarter output. But the way to accelerate GDP growth is by boosting the private economy, not re-inflating the public sector.
The nation’s gross domestic product, adjusted for inflation, grew at an annualized rate of 2.5% in the year’s first three months. Hardly a great number given the huge gap between GDP’s pre-recession trajectory and where we are now. (See above chart). The economy is not growing fast enough to close that multi-trillion dollar growth shortfall (or a similar one in the job market). And last quarter might be the strongest of the year.
But consider: The data continue to suggest a tale of two economies. Real GDP growth has averaged only 1.4% over the past two quarters, notes RDQ Economics. But private-sector GDP — excluding government consumption and investment — grew 4.0% in the first quarter and has averaged 3.0% over the past two quarters — about what it did from 1983-2007. Falling government output is what’s tamped down the overall growth number. In the first quarter alone, the 4% decline in government spending knocked a point from GDP. Indeed, government has subtracted from GDP for 10 of the last 11 quarters.
But is that a bug or a feature of this recovery? The decline in government spending — the sharpest year-to-year contraction in real federal outlays since Ike’s Korean War demobilization — continues and is no doubt taking some toll on private-sector growth. The fiscal cliff tax hikes, too. Yet not only is the private sector growing at trend, but job creation is averaging 200,000 month. Not a boom, but not stagnation, either.
The wisest next step isn’t another massive fiscal stimulus simply to boost government’s contribution to GDP. Longer-term, smaller government — provided that there is enough spending on public goods like defense and basic research — is good for the economy. (Most recent studies finding a negative correlation between government size and growth.) Expand the most productive bits of the economy, not the least efficient ones.
US spending austerity — though some should be offset by entitlement savings — is roughly on the right trajectory. What’s needed now are measures to aid business, including tax cuts and more high-skill immigration, as well as continued monetary easing.
Special thought also should be given to the long-term unemployed. Skill degradation and workplace bias might mean a rising tide won’t lift their boats. AEI economist Kevin Hassett recommend policymakers investigate a number of options, including tax subsidies for hiring, workplace sharing programs, and helping workers move to areas with higher job growth.
Growing the economy doesn’t have to mean growing government.