GDP growth and Goverment Spending.

Andrew Jackson, 7th President of the
United State's last words were
"I killed the Bank" Quote for truth.

After spending a post comparing average ten year growth rates. I decided to throw up a ten year rolling growth rate chart, where each year’s growth rate shown on the chart is an average of the previous ten years.  What it does show is that after tthe end of the 1940s we have not held decade long growth above the national average, excluding the 1960s.  During the 1940s we had a ten year rolling average showed near 10% growth that included part of the years of the great depression and WWII.  Now ostensibly this makes sense because our federal government added so much extra money to the economy via government sponsored projects, the resulting deflationary pressure due to people turning in their increasingly worthless paper money into gold, forced FDR to confiscate private stores because it decreased the money supply making it harder for the government to continue deficit spending.

I then did some digging around and found out how much the government spent each year from 1792.  This gave me an opportunity to ask a few questions.  Would our economic growth look much different sans government spending?  I think this would give us a better picture of the overall health, and trajectory, of our economy. 

Now, there are individuals that would argue that you cannot simply subtract government spending out of GDP; that spending on social services and defense has net economic benefits to society. I am personally inclined to disagree. While I would be willing to concede that it is morally just to have a social safety net for those temporarily without work due to economic conditions, or those who are simply mentally incapable for normal work due to circumstances outside of their control, I would argue that such spending accounts for a very small portion of social services. Much of it amounts to little more than a transfer of wealth from the most productive to the least. 

Secondly, while I am no dove, I am disinclined to think military spending is a net economic plus as well.  Yes it makes sense to spend money on our national defense, but at what point do we hit diminishing returns?  Is spending 5% of GDP on defense the right amount, or is it 25% of GDP?  That number is a moving target and it depends on the situation our nation finds itself in, and one thing I do know, and a former President by the name of Eisenhower would agree, that we have a military industrial complex that compels us to spend money on military projects, even if those funds could be better spent elsewhere.  So I decided to take out all of government spending from GDP. Yes state and local spending will still be accounted for, but I simply would not be able to find data on state and local government spending going back to the 1790s, so I will not agonize over it. 

 The blue line of the chart shows real GDP growth, according to 2005 dollars and the red line shows GDP growth less government spending. From this point on I will call this figure economic productivity.

What we see when looking at this chart is that for much of our history government spending amounted to a very small portion of GDP, around 2-5%, so this means that most of our economic growth was driven by private enterprise and local projects. Even during the civil war government spending didn’t top out above 15% of GDP, and you would be hard press to see the divergence between GDP and GDP less federal spending.  It isn’t until 1918 that we see a real divergence, and even then only temporarily, as government spending shoots above 20% as we dealt with WWI.  The permanent disconnect between the two GDPs charted, occurs right around FDRs presidency. The New deal began tremendous expansions, especially considering that it was peace time, of government spending.

Now while many a middle school teacher will say that the New Deal helped end the depression, few economists will say as so.  At most you will hear them say that FDRs actions prevented the economy from getting worse.  But even some ardent Keynesians economists, my college professor being one of them, will admit that FDRs actions were less than effective. The classic defense of government spending comes from WWII.   They argue that there was a real need for government to increase spending to fight Nazi Germany and Imperial Japan.  I wouldn’t argue against them, there was a real need, however, as this chart shows, there were serious economic consequences that resulted.

Even though GDP grew during WWII we see that real economic activity decreased.  This explains why the US economy contracted after the end of the war.  When the nation demobilized the economy had to reset to levels supported by private enterprise, in fact, we see that even during the 'after war recession', even as GDP shrank, actual economic production grew.  Too put it simply, the after war recession wasn’t a real recession, and that is the reason why it was so short.

As time goes on, we see that as government spending increases as a share of GDP, by the late 1950s spending would almost perpetually sit above 20%, the gap between the two charts increases.  It should also be noted, because it is easy to miss, that in 1965 federal spending decreased and that the rate of growth of non-federal spending GDP increased at a greater rate than overall GDP closing the gap between the two charts.  We also see the effects of the breaking of the Breton Woods agreement.

In 1972 Nixon said we would no longer redeem US dollars held by other nations for gold, effectively taking us off any semblance of a gold standard. In 1973 we experience a recession and the GDP chart shows it to be relatively mild, however, looking at the real economic activity of the nation, we see that the recession was more severe than official estimates because the federal government papered over the recession by increasing spending.  We never again come close to closing the gap between officially reported real GDP and actual economic production, even the New Economy of the 1990s doesn’t close the gap.

Lastly, we see that the recession of 2008 is much more severe, a near half a trillion dollar drop in economic production versus the drop of a hundred billion officially reported. Currently, according to this chart, our real economic activity (Real GDP less Federal spending) stands at just a hair under ten trillion dollars.  This is not good citizens, having anywhere from a quarter to a third of GDP being a result of federal spending means that a quarter or a third of GDP is illusory. The pundits are right to say that GDP would contract if we cut our deficit spending, however, what they fail to mention, or more than likely fail to realize, is that after the short term pain long term real economic growth can begin.

When I was looking at the data I decided to compare economic growth rates between Real GDP and Actual economic activity. The chart I made didn’t tell me much, it was too muddled and confusion, so I decided to take a ten year average and look at it then. 

What I found and you know see is that up until the 1930s we had instances of real economic activity outpacing GDP growth; meaning that real economic production, and not government spending, drove our economy.  In fact, prior to 1930 we had only 5 decades were government spending accounting for greater growth in GDP than economic production. T

he first instance occurred in the decade that the United States tried for a second time to create a national bank in 1816. It was this bank that caused the panic of 1819 by creating a massive property bubble.  The bank limped on until the 1830s, when Andrew Jackson killed it.  The next instance was government spending was a greater factor in growth than economic production was during the civil war.  It isn’t too surprising since the federal government grew dramatically during this period, and also issued it’s the second fiat currency, currency not backed by gold or silver, in the nations existence, the first was the continual.  The war notes, known as greenbacks, were discontinued after the war, and economic activity resumed. 

The US experienced the greatest growth in our history during the decades of the 1870s and 1880s; both periods were economic activity outpaced GDP growth. It wasn’t until the late gilded age, when wealthy robber barons tried to use government force to secure their monopolies that GDP backed by federal spending grew more than economic production.  The next two decades, known in politics as the progressive era, was a period of increased government spending and involvement in our economic affairs.  Economic production grew at a tremendous rate during the 1920s, but shrank dramatically during the 1930.

We see that since World War II there has been one instance of real productive economic growth outpacing GDP. It occurred during New Economy of 1990, when information technology systems were revolutionizing the United States.  Now, you see that outside of the 1990s, economic production grew almost as much as real GDP during the 1960s.  This was a period when government spending was decreasing during the early half of the decade.  However, the great society, and Nixon’s economic fallacies of removing us off of the final tie to gold and his price controls, saw a tremendous decrease in both GDP and economic growth.  But perhaps the most alarming is that we see that during this last decade, real economic production barely averaged above 1% growth.

This is the greatest relative gap we have seen between GDP and economic production since the 1930s, and it offers a dire warning for the United States.  The United States cannot use government spending to increase GDP growth. The growth rate chart shows that at best you’ll yield GDP growth 1% higher than actual production and more than likely only fractionally better, and more importantly, as government spending becomes a greater portion of GDP it makes GDP even less useful in telling Americans how the economy is doing.  Taking actual economic production and dividing it by our population would make our GDP per capita around 35,000 not 48,000. This doesn’t even begin to address the effects that rabid money supply increase has on GDP reporting.  But regardless of that fact, one thing that can be ascertained from the data I have presented, our economy is not doing nearly as well as our leaders would have us believe.