In the 1930s and 1940s, when
the modern system of national income and product accounts (NIPA) was being
developed, the scope of national product was a hotly debated issue. No issue
stirred more debate than the question, Should government product be included in
gross product? Simon Kuznets (Nobel laureate in economic sciences, 1971), the
most important American contributor to the development of the accounts, had
major reservations about including all government purchases in national
product. Over the years, others have elaborated on these reasons and adduced
others.
Why should government product
be excluded? First, the government’s activities may be viewed as giving rise to
intermediate, rather than final products, even if the government provides such
valuable services as enforcement of private property rights and settlement of
disputes. Second, because most government services are not sold in markets,
they have no market-determined prices to be used in calculating their total
value to those who benefit from them. Third, because many government services
arise from political, rather than economic motives and institutions, some of
them may have little or no value. Indeed, some commentators—including the
present writer—ultimately went so far as to assert that some government
services have negative value: given a choice, the people victimized by these
“services” would be willing to pay to be rid of them.
When the government attained
massive proportions during World War II, this debate was set aside for the
duration of the war, and the accounts were put into a form that best accommodated
the government’s attempt to plan and control the economy for the primary
purpose of winning the war. This situation of course dictated that the
government’s spending, which grew to constitute almost half of the official GDP
during the peak years of the war, be included in GDP, and the War Production
Board, the Commerce Department, and other government agencies involved in
calculating the NIPA recruited a large corps of clerks, accountants,
economists, and others to carry out the work.
After the war, the Commerce
Department, which carried forward the national accounting to which it had
contributed during the war (since 1972 within its Bureau of Economic Analysis
[BEA]), naturally preferred to continue the use of its favored system, which
treats all government spending for final goods and services as part of GDP.
Economists such as Kuznets, who did not favor this treatment, attempted for a
while to continue their work along their own, different lines, but none of them
could compete with the enormous, well-funded statistical organization the
government possessed, and eventually almost all of them gave up and accepted
the official NIPA.[1]
Thus did government spending
become lodged in the definition and measurement of GDP in a way that ensuing
generations of economists, journalists, policy makers, and others considered
appropriate and took for granted. Nonetheless, the issues that had been
disputed at length in the 1930s and 1940s did not disappear. They were simply
disregarded as if they had been resolved, even though they had not been
resolved intellectually, but simply swept under the Commerce Department’s
expansive (and expensive) rug. In particular, the inclusion of government
spending in GDP remained extremely problematic.
Generations of elementary
economics students since World War II have come away from Economics 101 having
learned, if anything, that gross domestic product is defined as
GDP = C + I + G + (X - M).
That is, GDP for a given
period, usually a year, is the sum of spending for final goods and services by
domestic private consumers, domestic private investors, and governments at all
levels, plus foreign purchases of U.S. exports minus American purchases of U.S.
imports.
This sort of accounting
supplies the basic framework for the Keynesian models that swept the economics
profession in the 1940s and 1950s, from which a key policy conclusion was
derived—that the government can vary its spending to offset shortfalls or
excesses of private spending and thereby stabilize the economy’s growth while
maintaining “full employment.” From the beginning, the most emphasized part of
this conclusion was that increases in government spending can offset declines
in private spending and thereby prevent or moderate macroeconomic contractions.
Much of the increase in
government spending in recent decades has taken the form of increased transfer payments—payments for which the government receives no current
good or service in return—such as Social Security pensions, disability
benefits, and payments via Medicare or Medicaid to subsidize program
beneficiaries’ health-care services. In 2000, such payments amounted to 56
percent of all federal spending; in 2011, they were more than 61 percent. Transfer payments do not enter the computation of national income
and product; only purchases of final goods and services do so. Keynesian
economists argue, however, that government may use increases in transfer
payments to cushion business slumps in the same way that it may use increases
in its purchases of final goods and services because increases in transfer
payments augment personal income and stimulate greater consumption spending,
hence greater investment spending, and therefore, from both sources, an
increase in GDP.
The foregoing issues have
taken on special cogency during the past five years, as the federal government
has greatly increased its total spending. Real total federal
outlays increased
by 32 percent, from $2,729 billion to $3,603 billion (in chained 2005 dollars),
between fiscal years 2007 and 2011. Although much of this increase has taken
the form of increases in transfer payments, the part that is included in GDP
has also risen substantially—at the federal level, it increased by 15.6 percent
(in real dollars) between 2007 and 2011. Some of this increase was offset by a
decrease in state and local government purchases of final goods and services,
which fell by 3 percent during this period. (Data come from BEA, Table 1.1.6, Real Gross Domestic Product, Chained Dollars.)
As the basic Keynesian model
implies, the recent increases in government spending appear to have prevented an even greater decline
in real GDP during the recession that began in the winter of 2007-2008. But
however that may be, because so much of this spending may have had little or no
value—or even negative value—in itself, the question remains as to whether,
despite what the official GDP figures show, the population’s true economic
well-being might have suffered a greater contraction than mainstream
economists, journalists, policy makers, and others for the most part believe.
To resolve this question, I
have computed what I call gross domestic private product (GDPP), which is
simply the standard real GDP minus the government purchases part of it. (Data
come from BEA, Table 1.1.6, Real Gross Domestic Product, Chained Dollars.) The
figure shows the movement of this variable from 2000 to 2011, the most recently
completed year.
Real Gross
Domestic Private Product (billions of chained 2005 dollars)
If real GDPP had grown at its
long-run average rate of about 3 percent per year during the period from 2000
to 2011, it would have increased by about 38 percent. In reality, however, GDPP
increased during this period by only 18 percent, or by about 1.5 percent per
year on average. (Real GDP, by comparison, increased by about 1.6 percent per
year on average, producing a small increase in the government share of GDP.)
So, during this period of more than a decade, private product grew at only
about half of its historical average rate. Between 2002 and 2007, while the
housing bubble was giving rise to seemingly buoyant growth even beyond the
housing sector, the good times appeared to have returned, but the inevitable
bust from 2007 to 2009 and the slow recovery since 2009 pulled the
intermediate-run growth rate for 2000-2011 back to an anemic level. The
recovery of the period 2009-2011 brought the GDPP back only to its 2007 level,
signifying four years in which no net gain had been made and much suffering had
occurred between the beginning and the end of the period.
Perhaps the most positive
statement we can make about the private economy’s performance during this
twelve-year period is that it has been somewhat better than complete
stagnation. But private product has lost ground relative to total official GDP.
Moreover, many of the measures taken to deal with the contraction—the
government’s huge run-up in its spending and debt; the Fed’s great expansion of
bank reserves, its allocation of credit directly to failing companies and
struggling sectors, and its accommodation of the federal government’s gigantic
deficits; and the government’s enactment of extremely unsettling regulatory
statutes, especially Obamacare and the Dodd-Frank Act—have served to discourage
the private investment needed to hasten the recovery and lay the foundation for
more rapid economic growth in the long run. To find a similar perfect storm of
counter-productive government fiscal, monetary, and regulatory policies, we
must go back to the 1930s, when the measures taken under Herbert Hoover and
Franklin D. Roosevelt turned what probably would have been an ordinary,
short-lived recession into the Great Depression.[2] If the government and the Fed persist in the
kind of destructive policies they have undertaken since 2007, the potential for
another great depression will remain. Even without such a catastrophe, the U.S.
economy presents at best the prospect of weak performance for many years to
come.
Notes
[1] Robert Higgs, Depression, War, and Cold War:
Studies in Political Economy (New York: Oxford University
Press, 2006), pp. 64-68; and Ellen O’Brien, “How the ‘G’ Got into the GNP,” in Perspectives on the History of Economic Thought, vol.
10, Method, Competition, Conflict and Measurement in the Twentieth
Century, ed. Karen I. Vaughn. (Aldershot, England: Edward Elgar,
1994), p. 242.
[2] Robert Higgs, Crisis and Leviathan: Critical
Episodes in the Growth of American Government (New York: Oxford
University Press, 1987), pp. 159-95; Higgs, Depression, War, and Cold War,
pp. 3-29.
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