Unexpected? Economic Growth Goes Into Red

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Q4 GDP -0.1
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Economic output in the final quarter of 2012 was inauspicious, as the projection of a paltry 1.2% turned out to be just .1% — in the red. The contraction of the economy may be revised upward after the Bureau of Economic Analysis and others crunch the numbers further; gratefully, the culprits for the economy being stuck in neutral have been found: the GOP and its brinksmanship over the fiscal cliff.

According to this line of thinking, the slight dip in government spending during last year’s holiday season was the cause of the GDP decline, and as such, the Republicans should just get out of the Democrats’ way. But an examination of the relationship to quarter-on-quarter changes show that this ‘underpants gnome‘ argument that “government spending + ? = GDP growth” is non-existent at best (h/t ZeroHedge).

Q4 GDP -0.1

Observe that the declines in government spending quarter-on-quarter do not correspond with decreases in GDP growth in the following quarter, quite the contrary. The increase in government consumption expenditure in 2012 Q3, as a matter of fact, precedes the decline in GDP growth in Q4. Again, there is no observable relationship in this data range; in other words, government spending does not automatically mean an increase in GDP.

And this makes some sense if one really thinks it out. Around 73% of new hires in June-December were government hires, which are financed by the productive sector of the economy. While government is good at providing public services, those who receive checks from the treasury use that money to consume production. Public sector workers can help train workers to add value to the economy, but there has to be more to it than just regulating stuff, educating people, and taxing workers. So as government grows, economies tend to shrink.

This really shouldn’t be a controversial argument, because if all that was needed to grow economies was the government spending money, then all nations would be rich. Those countries that have had centrally planned economies must eventually either rely on exports to market economies to stay afloat, or adopt market reforms, such as have been carried out in the high-GDP growth BRICs — Brazil, Russia, India, and China.

Regardless, since the country has indisputably increased spending, deficits and borrowing because of the last budget passed in fiscal year 2009 (which President Obama signed into law), then it makes little sense to blame the Republicans for a suddenly “unexpected” decline in GDP. As Jim Pethokoukis points out: “In August of 2009, the White House—after having a half year to view the economy and its $800 billion stimulus response—predicted that GDP would rise 4.3% in 2011, followed by 4.3% growth in 2012 and 2013, too. And 2014? Another year of 4.0% growth.”

The latest GDP growth projection for 2012? 2.5%. One wonders if that will be revised downward also, after the Fed tries another round of pumping. There are even murmurs of another “stimulus” (obviously, because the last one worked so well). It might take time, but people may someday figure out that government spending breaks the wealth-creation chain implied in the “multiplier effect,” for the same reason that food stamps don’t stimulate the economy.

It also makes little sense to blame Republicans for slower defense spending as a smoking gun for the GDP decline, especially when the president himself wants to slash defense spending by $487 billion over ten years. Krueger also suggested that Hurricane Sandy disrupted economic activity. This is an important messaging cue to bear in mind, since Keynesian theory ignores the broken window fallacy, and would hold that natural disasters eventually result in more economic activity. But it should be noted that economic activity does not always mean relative wealth creation.

In the past, the U.S. has had higher GDP growth, which came not from government spending, but from an expansion of manufacturing and technological innovation in the productive sector. If Americans want to get back to work and pursue making a better life for themselves and their children, that is where they should look to take their cues.

In terms of politics, the Democrat-led Senate and the president are not absent from the federal government’s politics; and since the United States is not a one-party state, nor should it be, both parties should compromise on commonsense budgets that do not overspend and rack up huge deficits moving forward.

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