Why Government Spending Is An Obstacle To Growth – Pacific Research Institute

Why Government Spending Is An Obstacle To Growth

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For too long, our economy has been growing unnecessarily slow. Since 2000, U.S. economic growth has been one-third smaller than the entire post-World War II average. Every day, working families struggle to make ends meet with median family incomes stuck in neutral.

Why is this the case? If you were to listen to the talking heads on CNBC or read the latest Paul Krugman column, you would be told that low annual growth rates of 2% is the “New Normal” for the U.S. economy. These pessimists say that forces out of our control are to blame for our declining economy — an aging population, low savings rates, and the waning IT revolution.

This simply isn’t so. And, not only is this time not unique, today’s stagnant economy has the same causes as yesterday’s periods of slow economic growth: bad government policies.

The focus on regulatory and tax reform is crucial, but so is fundamentally changing how the federal, state and local governments spend their budget, which is now up to $6 trillion a year, or about $50,000 per U.S. household!

Of course, neither the federal, state, or local governments earned these revenues. Instead, every dollar the government spends was earned by someone in the private sector. Since government expenditures are no different from any other economic good, initially government spending provides great value and, therefore, increases economic growth.

However, the more that the government spends, the less value the additional spending creates. At one-third of the size of the economy, total government spending is well past the point where additional expenditures add value.

This excessive level of spending explains why during the periods when the government’s share of the economy was generally growing, including the 1970s and 2000s through 2010s, economic growth was slower and household incomes stagnated. In comparison to periods when the government’s share of the economy was flat or declining, including the 1960s and 1980s through 1990s, economic growth was robust and household incomes grew.

As opposed to being an economic stimulus, the current size of government spending has become an obstacle to economic growth.

It is not just the size of spending that matters. How the federal, state and local governments are allocating their budget dampens growth as well.

Back in 1959, around 70% of all government expenditures funded traditional public goods and services — national defense, transportation and police protection. Today these programs account for 44% of all government expenditures.

Transfer payments, which were 20% of expenditures, now slightly exceed the expenditures on traditional public goods and services.

Perhaps most troubling, the rising burden from government expenditures is not leading to improved outcomes from public programs. Using education expenditures as an example, a clearly valuable public good, inflation-adjusted per-pupil spending on education has more than doubled over the past 46 years.

Yet, increased spending has not improved outcomes. In fact, studies indicate that above a certain threshold, how education dollars are spent matters, not the amount of money.

Education spending is not unique. As another example, total income-support expenditures, another important program, are more than $65,000 yearly for a family of three people. This is well above the poverty threshold for a family of three (about $20,000).

Moreover, if held to President Johnson’s goal of the elimination of poverty, then these programs are a failure. Despite spending trillions of dollars, the poverty rate has not changed since 1970 — if anything, it has become worse.

Hidden liabilities are also a threat. In addition to the unfunded liabilities of Social Security, Medicare, and state and local pension funds, when interest rates return to normal, interest payments on the national debt will triple, costing around a half-trillion dollars in additional interest payments annually.

Correcting these trends is an important policy reform that is necessary in order to revitalize economic growth.

And, just like any spendaholic, the first step is admitting that the problem exists. After admitting that there is a problem, the government’s next step is to create a reasonable budget constraint, and start living within its means.

For starters, Congress should restrict expenditure growth to below the expected growth rate in the economy. Such a constraint would force the government to start prioritizing spending, and start demanding greater accountability from the programs it does fund.

A tighter budget constraint also improves the incentives for Congress to address the oft-cited, but rarely addressed, problems with unfunded government liabilities.

While such actions will require hard trade-offs, the excessive amount of low-value government spending is worsening our current economic prospects. Reversing these trends will help the U.S. regain its lost economic mojo and dispel the myth that slower economic growth is here to stay.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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