Just about every article I’ve read on the sequester says that
the $85 billion in mandated cuts from discretionary spending in the
federal government’s fiscal year 2013 budget will decrease GDP by
about 0.6%. But is this true? As is the case with much of what has
been written about the sequester, the answer is, “not exactly.”
The 0.6% number comes from the Congressional Budget Office,
though many economists have come up with similar estimates. The
fact that government spending has an affect on GDP is not
controversial. The definition of GDP, after all, includes
government expenditures. The big question is what is the multiplier
— how much does every dollar of government spending increase GDP,
or conversely, how much does every dollar of reduced government
spending reduce GDP? The CBO has estimated that the sequester cuts,
on average, have a multiplier of about 1.1. That is to say, $85
billion in cuts will result in about $93 billion in reduced GDP.
The $85 billion in cuts, however, pertains to budget authority and
the real cuts to take place in fiscal 2013 are only about $44
billion, so using the CBO multiplier of 1.1 the actual calculation
would be more like $48 billion of GDP, or about 0.3% of a $16
trillion economy.
Therefore, if the CBO is right, the sequester, if left in place,
will reduce GDP in 2013 not by 0.6% but by 0.3%. But there is still
a big problem with this calculation. That problem is that the
proper multiplier is not 1.1, but something far closer to zero. But
surely, some will say, if government spending is part of the
calculation of GDP, then a decrease in government spending must
decrease GDP by a similar amount. Well, not exactly. If this were
really true after all, all we’d need to do to usher in prosperity
would be to increase government spending (and we just tried
that).
Let’s look at a little history. In 1990-91, similar to 2008-09,
we had a financially induced recession (the savings and loan
debacle). Over the 13 quarters after the end of the 1990-91
recession, per capita GDP increased by 7.2%. Compare this to the
current recovery in which per capita GDP increased by only 4.44%
over 13 quarters. From fiscal year 2009 through fiscal 2011,
however, the Obama administration doled out additional special
“stimulus” funds totaling $494 billion and billions more were spent
through the first half of fiscal 2012 (not including the Trouble
Asset Relief Program’s assistance to financial institutions and the
auto bailout). If government spending really did have a 1.1
multiplier (or much higher than that, as argued by President
Obama’s Council of Economic Advisors), per capita GDP growth after
the 2008-09 recession should have exceeded that of 1990-91 by at
least 3.5%. In reality, it was almost 3% less.
John Lott, writing for Investor’s Business
Daily, has noted that the countries whose economies performed
worst during the time frame 2007 to 2010 were the countries in
which per capita government spending increased the most, whereas
the countries that performed the best had the slowest rates of per
capita government spending increases. The best performers included
the Czech Republic, Hungary, Israel, Poland, Sweden and
Switzerland, all of which actually experienced reductions
in per capita government spending.
It is true that the 1990-91 recession is not completely
analogous to 2008-09, and the United States is not the Czech
Republic or Switzerland. Nonetheless, these real world examples put
the theory of a significant GDP multiplier for government spending
into question.
Now let’s take a look at some economic theory. The CBO estimate
relies on the Keynesian notion that if government spends money, the
recipients in turn spend more, thus creating economic growth. This
may by true to some degree under some circumstances. But every
dollar the government spends comes from somewhere. In the current
case, every marginal dollar the government spends is borrowed and
about 60% of new federal government debt is being “bought” by the
Federal Reserve. This spending is, therefore, by definition,
inflationary. So, if you “create” an extra 0.3% in GDP through
government spending, but in the process increase the general price
level by 0.3% through an increase in the money supply, at the end
of the day you have achieved nothing — real GDP will have remained
unchanged. Of course, all of these changes are not instantaneous.
At first, the increased spending/increased money supply will likely
spur economic activity, but over time the induced inflation of
price levels will in essence counteract the value of the stimulus.
That is consistent with the observed reality of the current
recovery — fitful, uneven, and over the long-term, flat.
It is also important to note that not all spending is equal.
Spending that increases economic growth in the medium to long term
has to be productive spending. Much of what we saw in the Obama
stimulus package was unproductive. Spending $2.5 billion to bring
Internet access to a few thousand rural residences at a cost of
nearly $350,000 per household, or millions for university social
science research grants, or $2 million to build a fire station that
had no firemen to house, or $20 million to put up road signs
declaring that the stimulus spending is putting Americans to work,
to name but a few examples, does nothing to promote actual economic
growth. Moreover, given the obvious temporary and unsustainable
nature of many of the stimulus projects, the various businesses
involved likely avoided as much as possible hiring on new full-time
employees, knowing they’d likely need to shed them in the near
future. Wasteful spending only serves to divert resources away from
more productive activities (both public and private), and so it not
only fails to generate real economic growth, it actually impedes
it.
The sequester is not the best way to trim spending, but it is
difficult to believe that the federal government operates so
efficiently that most agencies will have a hard time functioning if
forced to cut their budgets by a few percentage points. The Defense
Department, which is hit the hardest by the sequester, has
announced that it may need to reduce aircraft training flight time
and shorten naval deployments. This may be undesirable from a
national security standpoint, but spending less on fuel (much of
which is imported) and having sailors spending a little more time
at their U.S. home bases rather than at sea or at foreign locations
will not harm the economy. On the contrary, those cost reductions
might actually have a net positive impact. Given the
across-the-board nature of the sequester cuts, some cutbacks will
be truly regrettable. But the sequester will force government
agencies to do something they rarely are compelled to do — take a
hard look at how they operate and identify inefficiencies and
unnecessary expenditures. No doubt many bureaucrats will not be up
to the task, but it is still something taxpayers have a right to
demand.
The only way the sequester reductions can have a meaningful
negative impact on growth and employment is for consumers and
businesses to cut back on spending simply due to the fear that the
sequester cuts will bring hard times. Ironically (or not so
ironically, depending on your view of the Obama administration),
President Obama has been doing his best to stir up fear. Certainly,
the sequester cuts will come in handy as an excuse should all his
other initiatives that actually will curtail economic growth — tax
increases, costly Obamacare mandates, the regulatory swamp that is
Dodd-Frank — cause continued weakness, or even recession in 2013
and 2014.
As demonstrated by his schedule in the weeks leading up to the
March 1st sequester deadline, the President had no intention of
negotiating a deal with Republicans. Despite his calls for a
“balanced” approach to deficit reduction during the 2012 campaign,
he will continue to oppose any plan to reduce in any meaningful way
domestic spending because he is ideologically committed to the idea
of big government and using the power of government to redistribute
wealth. Furthermore, he appears to have an overriding political
interest in trying to show the cuts as being as damaging as
possible so he can advance the argument that spending cuts need to
be replaced by more tax increases. Controlling the growth of
government spending, however, is the key to sustainable strong
future economic growth. Unfortunately, all the argument over the
sequester misses the point that the real threat to our long-term
national solvency is not so much discretionary spending, but
entitlements. If the Obama administration is declaring that cutting
discretionary domestic spending by a few percentage points is going
to end life as we know it, just wait until we start debating
meaningful entitlement reform.
Photo: UPI
