Something to be thankful for: the US government has finally stopped holding back the recovery
It’s no secret that spending cuts (and tax hikes) have retarded America’s growth for the past four years. But data from the Bureau of Economic Analysis suggests that the era of austerity may finally have ended.
The following chart shows the contribution of government and private spending to annual GDP growth, since the start of 2005:
(Source: BEA, author’s calculations)
Until the middle of 2010, government spending supplemented private activity to boost total income. One can argue about whether any of this spending was actually valuable and whether or not it was worth the cost of financing it through taxation and borrowing — we would ask the same questions about building and furnishing houses in the desert, too — but the maths are straightforward.
Starting about four years ago, however, government spending cuts began to bite. At its worst, this austerity subtracted about 0.76 percentage points off the real growth rate of the economy between the middle of 2010 and the middle of 2011. If real government spending had remained constant at mid-2010 levels and everything else stayed constant, (yes we know these are big assumptions) the US economy would now be about 1.2 per cent larger.
Zooming in we can see that, before the recession, defence spending was the largest contributor to reported GDP growth, while more recent austerity was initially driven by cuts at the state and local level. Those lower layers of government, which typically account for around 60 per cent of total government spending, began contributing to growth again in the middle of 2013. The federal government is still cutting its real spending, but by much less:
(Source: BEA, author’s calculations)
Another way of looking at this is to break down real government spending into gross investment and current consumption. Note that we are using the BEA’s definitionsrather than, say, common sense, so spending on military boondoggles and bridges to nowhere counts as investment while educating the citizenry does not.
Overall, about one fifth of total government spending is classified as investment. But cutbacks in investment spending accounted for almost three fifths of the total austerity since the middle of 2010:
(Source: BEA, author’s calculations)
Focusing on investment, we can see that military procurement was the biggest contributor to reported GDP growth in the years before the crisis. This category of spending has also dropped the most from its peak — 26 per cent — although cuts in state and local infrastructure spending hit growth harder since they were larger to start with. That contraction was briefly offset by an increase in federal non-defence investment spending. State and local austerity just recently stopped, but federal cutbacks to the defence budget continue to take their toll on the official data:
Government consumption spending fell much less than investment in percentage terms but the impact on growth was large, especially before 2010, because the starting point is so much bigger. The recovery in state and local consumption spending occurred earlier than the recovery in investment spending. Meanwhile, defence consumption cutbacks have finally stopped being a drag on reported growth, perhaps due to the escalation of US military involvement in the Middle East:
We want to show you one last perspective, which breaks out government spending into defence and nondefence. Nondefence austerity, chiefly at the state and local level, was a significant retardant to growth in 2010-2012. That basically ended two years ago, however, and nondefence spending has actually been boosting reported GDP growth by a tiny bit since the start of this year.
A little more than half of the total decline in government spending since the middle of 2010 is due to military cutbacks, some of which obviously has to do with the withdrawals of US forces from Iraq and Afghanistan. Since the start of 2012, more than all of the decline in government spending can be attributed to reduced defence expenditures. For better or worse, this austerity also seems to have come to an end:
So while real nondefence spending is still about 5 per cent below its peak, real defence spending is about 12.6 per cent below its peak. Some of that is welcome, since it can be explained by the end of wars and recovery from the trough of the recession, but some of it represents a self-inflicted wound. The good news is that an increase in the military budget might actually be something the politicians can agree on.