Jan. 28, 2012 – 1:05 p.m.
Political Economy: Facing Facts
By John Cranford, CQ Columnist
It became ever more clear last week that government spending is really hurting the U.S. economic recovery — but not at all in the way that many Republican lawmakers and presidential candidates would have the public believe.
This is not about what some regard as the adverse effects of government spending to goose the economy. It’s just the opposite.
Economic growth would have been half a percentage point stronger last year had it not been for deep retrenchments in local, state and federal budgets. Austerity — which is the order of the day from Albany to Sacramento to Washington — is luffing the economy’s sails in a significant way. And that’s not going to change any time soon. In fact, the effects may become more pronounced in the next several years, even if the economy as a whole strengthens.
The details contained in the first estimate of gross domestic product for all of 2011, released Friday, were pretty stark. A drop in government spending at all levels subtracted from economic growth in the second, third and fourth quarters of last year. The annualized GDP growth rate of 2.8 percent in the fourth quarter was pulled down by almost a full percentage point by the contraction in government activity.
After adjusting for inflation, spending at all levels of government was almost $55 billion less in 2011 than in the previous calendar year, Commerce Department calculations show. Spending fell or was flat in essentially all categories. In real dollar terms, federal spending on defense activities fell by almost $17 billion, and non-defense spending fell by more than $4 billion. At the state and local level, the cutting has been even more severe, with real spending down by almost $34 billion.
It doesn’t take much to connect the dots. These cutbacks began with the financial crisis and the Great Recession, which undercut tax revenue and forced state legislatures and local governments to move quickly to keep their books more or less in balance. In the early going, particularly in 2009 and in 2010, federal stimulus spending picked up some of the slack and funneled aid downstream to state and local governments. But that has mostly run its course.
Add in the military’s withdrawal from Iraq and the beginnings of a pullback from Afghanistan. And then layer on the forced spending constraints last year that became a test of the two parties’ commitments to federal fiscal responsibility. All told, the cutting at the federal level has just begun. Something on the order of $2 trillion (somewhat less when inflation in taken into account) will be withdrawn from the budget over the next decade under constraints enacted into law last August.
A portion of that reduction will show up in what will essentially be stagnant appropriations for the coming fiscal year. That’s not the half of it, though. An additional cut of about 9 percent will be taken out of whatever money is appropriated for fiscal 2013 next January.
Trading Public for Private
Fiscal conservatives, of course, want to cut much more, while some at the other end of the ideological spectrum would reverse course and boost spending as long as the recovery remains tepid. The latter is highly unlikely. And even if lawmakers were to take steps to mitigate the planned reductions, there is no doubt that the trajectory of federal spending is headed down.
That will further constrain the recovery, at least in the short run. Mark Zandi, chief economist at Moody’s Analytics, projects that planned fiscal policy actions at the state, local and federal levels would shave more than a full percentage point off GDP growth in 2012 alone. Lest the point be lost, slower growth will mean fewer new jobs and a longer delay in bringing down unemployment.
Leaving aside questions of which economic activities are more properly undertaken by governments or private companies, there’s a serious macroeconomic debate here. The Republican argument is that government generally inhibits private activity. Cutting back on public spending gives room for private growth, they insist.
Political Economy: Facing Facts
Perhaps that’s true, but the point may be far more nuanced. Government spending added considerably to GDP in the 1980s and 1990s, two periods of historically long economic expansion when there was little suggestion that government — broadly speaking — was impinging upon private growth. Government spending grew every year from 1995 to 2000, for instance, and private investment increased during each of those years at double-digit rates. No clear trade-off there.
And private investment slowed considerably in the fourth quarter of 2011 even as government spending was sharply curtailed, providing no evidence there of a shift from public spending to private activity. Moreover, logic dictates that companies doing business with the government will falter as public spending slows, which suggests, at best, a lag in this presumed transition.
Forecasts of economic growth will receive more attention than usual in coming weeks as the budget season gets under way, with revised projections from the Congressional Budget Office this week and the administration in mid-February. The likelihood is that their earlier growth estimates for the next year may be pared back.
Some of that slowdown will be a result of government spending reductions enacted in the past few months, a fact that lawmakers might bear in mind as they sharpen their knives for deeper cuts.