Larry Kudlow tries to use the fact that the fall government spending in the fourth quarter of last year was associated with a big drop in GDP growth to argue that lower government spending is good for the economy. Antonio Fatas correct his misguided thinking:
Celebrating negative growth, by Antonio Fatas: GDP growth during the last quarter of 2012 turned negative in the US (-0.1%)… Looking at the different components of GDP, the biggest decline happened in government spending and in net exports (due to the weakness in other economies). This is just one quarter and the data is likely to be revised later in the year, but what is to be learned from the data? The answer is whatever justifies your priors. Here is the interpretation that Larry Kudlow does in CNBC…
He makes the claim that this is indeed a good quarter because private spending (consumption and investment) grew at about 3.4% – after removing inventories that fell significantly. From here he concludes:
“Even with the fourth-quarter contraction, the latest GDP report shows that falling government spending can coexist with rising private economic activity. This is an important point in terms of the upcoming spending sequester. Lower federal spending, limited government, and a smaller spending-to-GDP ratio will be good for growth. The military spending plunge will not likely be repeated. But by keeping resources in private hands, rather than transferring them to the inefficient government sector, the spending sequester is actually pro-growth.”
So this is an interesting test that he is using to prove that decreasing government spending is good for growth. As long as we see any growth in private spending it means that the decrease in government spending is helping the private sector grow. Of course, the real test is to compare the -0.1% to what would have happened to GDP growth if government spending had not decreased. Reading Larry Kudlow’s article it sounds as if GDP growth would have been even lower (although his statement is not as precise as this). Yes, consumption grew and investment (once we exclude inventories) grew as well, but how much? Not enough to compensate the decrease in government spending so the final outcome is a negative (literally negative) performance for GDP growth. …
We see that government spending fell and this is a component of GDP. A natural reaction might be to argue that the fall in government spending had a negative effect on GDP. Given that the GDP growth number is so low (and lower than expected), this is a reason to believe that the multiplier is positive and possibly large. But, as Larry Kudlow shows, there are always other interpretations.
According to Kudlow’s theory (which is contrary to the empirical evidence, but why should actual data matter when there’s ideology to promote…note how he tosses inventories aside when they don’t agree with his priors, doubt he does that if it is helpful to his case), a decline in government spending should cause the private sector to boom by more than enough to offset the decline in government spending (otherwise growth would fall on net). Yet he is pleased that the decline in government spending didn’t cause a decline in the private sector (“shows that falling government spending can coexist with rising private economic activity”), as though that somehow supports his case. It doesn’t. Government spending fell, the private sector didn’t boom by anywhere near enough to offset it, and the net result was a decline in GDP growth.[Note: As Antonio points out, “we should not be doing this, to understand fiscal multipliers we need more than one quarter of data, but I am just trying to follow his logic.” For example, to qualify this is a way that could be helpful to Kudlow, there may be lags between changes in government spending and changes in private sector activity that cannot be captured in a single quarter of data. But as noted above, this actually doesn’t help — when the empirical analysis is done correctly, government spending multipliers in a depressed economy appear to be relatively large.
Let me add one more thing. I’m all for maximizing growth (with externalities internalized), but I’m also for full employment and sometimes a temporary increase in government spending in the short-run to put people back to work is the best course for long-run economic growth. This is one of those times, especially spending focused on infrastructure. Addressing our short-run problems in this way is, if anything, and contra the Kudlows, helpful for growth.
I don’t have any problem asking question such as “what is the best way to raise a given amount of revenue,” i.e. trying to minimize inefficiencies and inequities in the tax code with an eye toward growth. I also think it’s worthwhile to think about what size of government we want to have, and figure out the best way to support it. I do have a problem with high unemployment, especially when there are steps we could take to put people to work, and even more so when theories about long-run growth that have been rejected by the data are used to institute policies that work against helping people find employment in a depressed economy (e.g. austerity). In any case, with all of our employment problems, why would anyone cheer -.1 percent growth unless “those people” don’t matter?]