After dreadfully low growth in the last quarter of 2012—just 0.4 percent—gross domestic product (GDP) returned to a healthier rate of growth of 2.5 percent in the first three months of 2013.
The autumn’s drop in private inventories was reversed as companies stockpiled more goods in anticipation of future consumer spending. The 2.5 percent growth rate was not as high as markets had predicted, so stock futures fell on the news.
Good news in the GDP report included a rebound in trade (both imports and exports) and robust growth in consumer spending on durable goods. The private sector’s product grew at a 3.3 percent rate. The U.S. needs several years of private-sector growth above 3 percent in order to recover from the below-trend growth of the last four years.
During the Great Recession, government consumption grew rapidly. It has since stopped growing, but federal spending is still too high. If Washington can unwind more of the recession-era spending boom and do away with costly, ineffective programs and stifling regulations, it could allow greater investment, competition, and growth in the private sector.
Government consumption and investment declined, principally in defense, which contracted at an 11.5 percent annualized rate, continuing a decline in late 2012. Since the budget sequester hit defense hardest, we should not be surprised if the decline in defense spending continues throughout 2013.
Those who believe that government spending leads the rest of the economy will be disappointed that while government declined 4.1 percent this quarter, private GDP grew at a spritely 3.3 percent.
While all government spending may appear the same, it is not all counted in GDP calculations. GDP includes “government consumption and investment expenditure,” which includes items such as new aircraft bought by the military and the electric bill of an elementary school. Direct cash transfer payments, such as Social Security and the Earned Income Tax Credit, are counted only if individuals spend them or (indirectly) if banks invest them. Constrained transfers, such as Medicare and food stamps, are counted as private consumption expenditures, even though the government pays the bill.
As the large entitlement programs continue to grow (due to an aging population, rising health care costs, and Obamacare), they may crowd out more and more other functions of government. Thus, GDP could show falling government consumption and investment while total government spending actually grows. This is one among the many reasons to consider GDP as one of many indicators of the size and shape of the economy—not the only one.
Another unique feature of government consumption is that it includes the salaries of all government workers. Salaries in the private sector, however, are not counted. This reflects the fact that most government-produced goods are “public goods,” which are provided to users regardless of their tax payments. Rather than trying to put a price on the value of public safety, public broadcasting, or public swimming pools, the Bureau of Economic Analysis assumes that the value of these goods is the amount the government spends producing them. That means that a highly efficient or highly valued government service is counted equally with an inefficient and unvalued one, as economist Garett Jones has argued.
It is important to remember that there is a distinction between value and GDP. Policymakers are sometimes tempted to focus on “raising GDP” and can do so directly—in the very short term—by hiring more government employees. But useless hiring is of no good to the people who make up the true economy.