Government spending does not create economic growth. Regrettably, many in Congress, Republicans and Democrats alike, have ignored this fact. Just today, Senator Judd Gregg (R-NH), declared in his Wall Street Journal op-ed How to Make Sure the Stimulus Works that, “it is fairly obvious that serious deficit spending is needed immediately.” While his four rules for an effective stimulus bill are generally correct, government spending does not lead to economic growth.
This notion is grounded in the outdated and often disproved Keynesian economic theory that more government spending invariably increases economic growth. Thus, the more the government spends the better. This ignores the fact that every dollar that Congress “injects” into the economy must first be taxed or borrowed out of the economy. Therefore, government spending merely redistributes money from one part of the economy to another.
In reality, economic growth – the act of producing more goods and services – can be accomplished only by making American workers more productive. So the best measure of a policy’s impact on economic growth is through productivity rates.
Numerous academic studies have shown that government spending often does not increase productivity rates and therefore is not correlated with economic growth due to:
Taxes. Government spending is financed by taxes, and high tax rates reduce incentives to work, save, and invest.
Incentives. Social spending often reduces incentives for productivity by subsidizing leisure and unemployment.
Displacement. Every dollar spent by politicians means one dollar less to be allocated based on market forces. Rather than allowing the market to allocate investments, politicians seize that money and earmark it for favored organizations.
Inefficiencies. Government operations are often much less efficient than the private sector. Politicians earmark money for wasteful pork projects rather providing funding for essential projects.
Keynesian economic theory is most prevalent in the development of highway spending policy. The source of the assertion that government spending on highways will create jobs stems from a misrepresentation of a Department a Transportation study stating that for every $1 billion spent on highways, 47, 576 jobs will be added to the economy. The report didn’t actually make this claim, but rather that $1 billion in highway spending would require (not create) 47,576 workers. But before Congress can spend $1 billion on highways, they must first tax or borrow $1 billion from elsewhere in the economy. This type of redistribution creates little, if any, economic growth.
The Congressional Research Service addressed this issue in 1993, stating:
To the extent that financing new highways by reducing expenditures on other programs or by deficit finance and its impact on private consumption and investment, the net impact on the economy of highway construction in terms of both output and employment could be nullified or even negative.
At a time when many American families are struggling Congress should be focused on a pro-growth stimulus package, not a politically driven government spending bill.