Is Government Spending Hindering the Recovery?

Not only is America's economic recovery an outlier, so too is Washington's spending "response." Today's dramatic dual divergence from past economic and fiscal performances reveals a number of important conclusions and raises equally important questions. Chief among the latter: Is the significantly higher federal spending response muting the longer-term economic recovery?

Over the last 55 years, there have been five years in which the nation's economy has contracted: 1958, 1975, 1982, 1991, and 2009. Examining these, a "surge and shrink" pattern to federal spending appears - rising above its decade average, then returning toward that average over the next four years.

However in each of the first four instances, the economy performed far better and federal spending surged far less, and returned much more closely to its normal level, than has the current period's.

In the 1958 downturn, federal spending was 17.9% (versus 17.6% in the 1950s and 18.6% during the 1960s, as America's entitlement spending began in earnest) and the economy shrank 0.7%. Over the following four years, federal spending averaged 18.4% and the economy grew an average of 4.6%.

In 1975, federal spending was 21.3% (versus 20% during the 1970s) and the economy fell 0.2%. During the next four years, federal spending averaged 20.7% and the economy averaged annual growth of 4.7%.

The 1982 downturn saw federal spending at 23.1% of GDP (versus 22.2% in the 1980s) and the economy fall 1.9%. The next four years saw federal spending at 22.7% (as America armed up to end the Cold War) and the economy annually average 4.9% growth.

Finally in the 1991 recession, federal spending was 22.3% of GDP (versus 20.7% in the 1990s) and the economy slipped 0.1%. Over the following four years, federal spending's annual average was 21.3% and the economy averaged annual growth of 3.25%.

The big break in this pattern comes in our current period. In 2009, federal spending shot to 25.2% of GDP (versus the 2000-2009 average of 20%) and the economy fell 2.8%. Assuming Congressional Budget Office 2013 estimates for federal spending hold, and that the economy grows for the year at Q2's 1.7% rate (significantly better than Q1's 1.1%): over the four-year post-recession period federal spending would average 23.1% and economic growth would average just 2.2%.

Current spending has surged far more than the previous periods'. Current spending soared by 5.2% of GDP in 2009 over its decade average - that compares with 1991's 1.6%, 1982's 0.9%, 1975's 1.3%, and 1958's 0.3% versus 1950 (and actually 1.3% below the 1960s average). It has also fallen far less during the following four years - still 3.1% of GDP above the 2000-2009 spending average, while 1991's was 0.6% above the 1990s' average, 1982's was 0.5% above the 1980s' average, 1975's was 0.7% above the 1970s' average, and 1958's was 0.8% above the 1950s' average (and 0.2% below the 1960s').

The last four years' growth is also well below the previous periods'. Except for the period following the 1991 downturn (where it is still averaging a full point less) it is less than half of the other three periods' - this in spite of unprecedented and prolonged federal spending and historically low interest rates.

The post-1991 expansion warrants special scrutiny, since this period preceded the current downturn, and is where today's economy still aspires to return. Lasting 16 years from 1992 through 2007, and equally split between Republican and Democrat administrations, federal spending averaged 19.8% of GDP and the average annual GDP growth was 3.2%. Our current post-recession period has averaged spending 3.3% more of GDP and average economic growth is 1% lower.

It is inescapable that something very different is occurring in the nation's economy and in Washington's response to it. Now four years old, we really are no longer talking about a "recovery."

Similarly, we now are no longer talking about "stimulus spending." If people are going to say that federal spending aided the economy in the short-term, then they must also admit that it has had much less economic impact - despite its much greater levels relative to the economy and for longer durations.

We must also recognize that resources used by the federal government are resources thereby diverted from the private sector. These are resources the government, not the private sector, is allocating. If we are doing a full examination of the current period's economic shortfall, we must be open to the thesis that the government's resource allocation is not what the private sector would have done or as productively.

The ultimate questions therefore become: Have we now entered a longer-term scenario of lower economic performance, as we are also entering a longer-term period of increased federal spending? How long then does this coincidence need to continue before we ask whether the former response to the economic downturn has now become the current cause of its under-performance?