According to a recent report by the Bureau of Economic Analysis (BEA), U.S. real gross domestic product (GDP) increased at an annualized rate of 3.2 percent in the 4th quarter of 2013. For all of 2013, real GDP increased by a mere 1.9 percent, down from an increase of 2.8 percent in 2012 and below the long-run average of 3 percent (see GDP growth figure below).
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The BEA’s calculation of real GDP includes the summation of four major components: consumption, investment, government spending, and net exports.
During the 4th quarter, the main contributors to the 3.2 percent increase were consumption (+2.26 percent), investment (+0.56 percent), and net exports (+1.33 percent).
With the federal government “shutdown” in October, state and local government expenditures shaved off (-0.93 percent), which would technically-as measured by the BEA-have contributed to real GDP growth of over 4 percent had it not declined.
Some argue this “fiscal drag” slowed economic growth; but with government spending expected to increase in coming quarters, there should be a faster expansion.
This begs the question: If more government spending brings about economic prosperity-as argued by Keynesians, why should we limit it? Why not have one stimulus package after another? Why not run up large deficits and print money so we do not have to pay higher taxes?
Fortunately, even though some argue that these are wise measures, there is clear evidence that more government spending means fewer dollars are spent in the private sector, thereby slowing economic growth. This “crowding out” effect, as it’s called by economists, happens through several mechanisms that reduce private sector dollars: raising taxes, higher interest rates because of new bond issuances, higher inflation from printing money that tends to push people into a higher tax bracket-also known as “bracket creep”, or some combination thereof.
Interestingly, the large increase in national debt over the last five years has led to little inflation, as measured by the Consumer Price Index; however, banks are easing their lending standards after years of tightening and holding trillions of excess reserves at the Fed. This has acted as a foot on the brake of inflation, but soon this may ease and more prices will rise.
There is no doubt, 2013 was another year of subpar economic growth compared with past expansions.
The figure below of GDP during each expansion shows the change in real GDP by quarters during each expansion. The red line represents the current post-recession recovery that started in 2009. Compared with the other expansions listed, this recovery is historically slow. The current recovery is about 10 percentage points below the pre-2009 expansion average. In other words, after almost five years of economic expansion, the economy’s growth is 50 percent slower relative to the pre-2009 expansion average.
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The next figure comparing most post-WWII expansions shows the current slow rebound more directly. The average quarterly change in real GDP during the current expansion is only 2.4 percent, substantially slower than all post-WWII recoveries, which contributes to the depressed labor market.
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Sure, the most recent recession was more severe than most of the recessions listed, but typically economies bounce back faster after a steep recession. Think of it as a basketball. The harder you push it down, the faster it bounces up. This has not been the case with the national economy.
However, we do not know that policies matter. If you consider Texas, the state had a relatively severe recession, but it was shorter and bounced back much faster without large increases in government spending.
The Texas Comptroller notes the stark divide between the U.S. and Texas recoveries by the following:
Pre-recession Texas employment peaked at 10,635,700 in August 2008, a level that was surpassed in September 2011, and by December 2013 Texas added an additional 641,400 jobs. In the U.S. as a whole, only 87 percent of recession-hit jobs were recovered by December 2013.
Texas and the nation returned to economic growth in 2010 and 2011, respectively. In calendar 2012, Texas real gross domestic product grew by 4.8 percent, compared with 2.5 percent for the U.S.
The current U.S. recovery calls for a vastly different policy approach that aims at growing the economy and increasing productivity and wages, rather than at short-run changes that cause a “fiscal drag” on private sector expansion.
The limited government approach in Texas and in other states across the country works well and should be the framework that other states and the federal government should follow for economic prosperity to flourish.
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