Is the Dreaded Government Spending Doing its Part?

August 6th, 2012
in Op Ed, syndication

by Ricardo Cornejo, GEI Associate

Just as famous as the dilemma of “the chicken or the egg,” the impact of government spending on economic growth is equally as mind boggling. Not in the sense of which one came first, but instead in its recurring, two pronged effect on economic growth. Some maintain reductions in government spending will spur growth; others say it will cause growth to sputter. So it should come as no surprise that government spending could be held at blame for the current economic slowdown by all kinds of arguments.

One of these arguments is that the shrinking of public outlays for the last 8 consecutive quarters now carries some responsibility for the slowing down of the economic recovery, offering a preview of the future - in the case that these patterns continue. Others argue that reduced government spending is required to obtain increased private investment.

Even though it is not yet certain that the expiring tax cuts and instant cuts to public expenditure will indeed take effect early into 2013, their potential impact appears to be beginning to take a hit on the performance of the recovery through decreases in Real Government Expenditures.

Follow up:

The Department of Commerce indicated that Real Federal and Real Local and State Government Consumption Expenditure decreased by 0.03 percent and 0.26 percent, respectively, during the second quarter of this year for an estimated total of a 0.28 percent decrease in the Real Government Consumption Expenditure and Gross Investment (from now onward RGCE). In relation to our outstanding government debt, this is great news as spending has decreased. On the other hand, comparing this behavior to Private Investment and Personal Consumption Expenditure leaves a margin of doubt about the “goodness” of these news.

After the second quarter of 2012, RGCE were at about $1 million less compared to what they were at the beginning of the recession in January of 2008. They have been on a downward path since the second quarter of 2010 while Personal Consumption and Private Investment have been, more or less, on the rise.  Of course, most of the burden of the slowdown in the economic recovery is carried by the decrease in Personal Consumption, as the rate of growth decreased from 1.72 percent in the first quarter to 1.05 percent in the second quarter.  Despite this, the Department of Commerce and several analysts have attributed the slowdown, in part, to the decrease in RGCE.

So, could it be that the decrease in the dreaded government spending is tying down the expansion? The answer could be in the comparison of RGCE in previous expansions.

As observed in the graphic, the current expansion differs greatly from previous ones, as in none of them has RGCE ever decreased below pre-recession levels throughout the expansion. RGCE has indeed began decreasing after 4 quarters into an expansion in the past, but never at the rate observed during the present expansion. The last 2 major recessions, 1974-1975 and 1981-1982, both lasted 5 quarters and saw increments, moderate to substantial respectively, in RGCE during their recovery. This perhaps contributed to the speed of the expansions observed thereafter as RGCE grew together with the growth in Personal Consumption and Private Investment.

Increasing public outlays, however, doesn’t seem to be the intuitive solution to the tortoise-like growth plaguing the United States economy, as the public fears the longstanding US debt. A climbing debt cloud is often casting a shadow on a bright, confident day in the market and while increasing government expenditure could be the answer, creating a more confident economic climate for households to spend their increased earnings could be another driver of Real GDP growth.

The 8 consecutive quarters of decreasing government expenditure highlight the dire necessity of finding a solution to the Fiscal Cliff problem, as the public wonders what could happen if RGCE continues to decrease at a fast rate. Approximately 40 percent of the Federal government stimulus adopted during the recession came through way of the extended tax cuts to the middle class and small businesses which encouraged Personal Consumption and Private Investment. If the looming Fiscal Cliff were to become a reality, the recently observed impact of decreases in RGCE on economic growth could be emphasized by the reinstatement of taxes which could inhibit further growth because of increased withdrawal of money from the private sector.

When the increase in withdrawal of money via higher taxes also coincides with a further reduction in government expenditures (also reducing money fow to the private sector), the economy is faced with a double whammy.

The edge of a Fiscal Cliff continues to close in fast on a slow-paced jogging economy with no sight of relief as election season nears.  Are we going to find out if removing money from the private sector can coincide with economic improvement?



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1 comment

  1. Frank Li (Member) Email says :

    Government spending in democracy has never really worked! It did not really get the U.S. out of the Great Depression (WWII did), nor will it get the U.S. out of today's Great Recession! In other words, Keynesian economics has never really worked. Rather, it is bringing down the West as spectacularly as Marx's communism brought down the East. For more, wait for my article soon: "Karl Marx and John Keynes".



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