What's Gross About Our Gross Domestic Product?
The health of an economy is too-simply described by GDP growth. If I sue you, and you countersue me, our collective legal fees increase GDP handily. Excellent! If government passes additional laws to increase the complexity of the tax code and the burden of regulatory compliance, and then hires additional staff to better enforce these more-complex laws and regulations, GDP rises handily. If our employers hire additional people to address these new levels of complexity and regulation, GDP again rises handily. Better still, the "Keynesian multiplier" applies to the spending of these attorneys and bureaucrats and the private sector employees hired to serve our more aggressive government masters.
These examples are not all-encompassing. We could all point to countless elements of GDP growth that do not leave society better off. Indeed, it might often be more accurate to subtract these costs from GDP, rather than adding them!
These examples are not offered to suggest that government spending is inherently nefarious, as some libertarians might suggest. We could all point to the roads, the civil defense, the policemen and firemen, as examples of public spending for the public good.
Keynes argued that if the government hires ditch-diggers to dig holes, and ditch-fillers to follow behind filling in those holes, their spending creates a multiplier effect, so that the economy grows beyond the cost of the ditch-diggers and fillers. If the multiplier for the private sector economy is only modestly negative, then we can have a fruitful debate about the merits of stimulus. However, most would agree that it's not a good thing when public spending is devoted to make-work tasks, especially if we additionally force the private sector to "make work" in order to meet a growing regulatory compliance burden.
The competing views on the Keynesian multiplier have been tested repeatedly, with mixed results. These tests typically assume that all GDP is good. But, we know that's not always true.
The "Austrian School" and libertarians believe that the private sector is inherently responsive to the requirements of its clientele and is therefore the real growth engine for the economy, for employment and for the supply of goods and services. If so, then even a small negative multiplier on the private economy is a bad thing.
What if we (still too simplistically) assume that growth in the private sector is generally good, while growth in the government portion of GDP is a mixed blessing? After all, for most of us, when we want goods and services, we go to the private sector to buy them, apart from the occasional call to the police or fire department. When we test the linkage between public spending and growth in the private sector economy, we find a startlingly different picture. We find a negative Keynesian multiplier. We find "crowding out."
From 1952 through 2009, each 1% change in US government outlays as a percent of GDP was accompanied by a 1.8% shrinkage in the private sector (the non-Government GDP). If we ignore the extreme outlier year of 2009, the multiplier actually increases from 1.8 to 2.4. And, the statistical significance is off-the-charts. If we go back to the turbulent years of the Great Depression and the two World Wars, we find similar results. It would appear that the Keynesian multiplier, redefined to tie government outlays to the growth in the private sector economy, is about -2.
The linkage is very clear and very powerful, but causality is less clear. Does a tumbling in private economy GDP trigger government outlays, or do soaring outlays cripple the private economy? On one level, it doesn't matter: if the multiplier is worse than -1, the net damage is self-evident.
The private sector multiplier is about -2. Japan has seen the downside of an overreliance on stimulus for 20 years. Now, the US and UK, along with the Mediterranean EU member states, derisively described as the PIIGS, are following a like path. Correct accounting shows US gross public debt exceeds each and every one of the PIIGS.
Much of the world is now pursuing a policy experiment that (1) has been tried repeatedly without success, (2) has highly significant - and discouraging - historical evidence, and (3) is now being tried on unprecedented global scale. The exit strategy is ambiguous or absent; we're borrowing with no clear means to repay our debts.
We face an added risk, from the sheer magnitude of our deficit and debt. Our deficit for 2009 was over 10% of GDP. Or was it? It soars to 18% of GDP, if we add in off-balance-sheet spending (legal for government, illegal for Enron), incremental debts for Fannie, Freddie and the other GSEs (backed by full faith and credit of the US Treasury, with no limit to the obligation, but somehow not considered part of our deficit or our debt), and new unfunded liabilities for Social Security and Medicare. Just to supply a frame of reference, this is twice Greece's deficit.
Our public debt is 40% of GDP according to the CIA 2009 World Factbook, down from 60% in 2007. Right? Well, they took the off-balance-sheet debt off the tally; apples-to-apples, we're at 85%, and rising fast. Add in the GSEs, plus state and local debt, and we're at 140% of GDP. Greece is at 115% of GDP. Add in the unfunded Social Security and Medicare obligations, and we're at 420% of GDP. Who has greasier accounting? Sadly, the US.
