April 30, 2013 4:25PM

Government Spending Up, Private GDP Down

It drives a lot of us at Cato nuts to read news stories almost every day which simply assume that government spending is good for the economy. Any defense or nondefense spending restraint will hurt economic growth, it is assumed. Even a recent AEI study seemed to accept this Keynesian concept.

Government spending certainly helps the government-dependent parts of the U.S. economy. But most Americans live in the private economy, and so they might like to know how government budget actions affect the economy that they live in.

So let’s explore the spending-to-growth relationship with national income accounts data. I ran a simple regression with 60 years of data, 1953 to 2012. The variable I was trying to explain was real private GDP growth. Private GDP is total GDP less the government portion of GDP from Table 1.1.5. The explanatory variable was total (federal/state/local) government spending from Table 3.1. Both variables were converted to constant dollars using the GDP deflator.

The chart below shows the Excel plot of the results. The downward slope of Excel's fitted trend line means that higher government spending growth in a year corresponds to reduced private GDP growth that year. For example, if real government spending growth was zero, private GDP would be expected to grow at 4.2 percent. If real government spending growth was 5 percent, private GDP growth would be expected to fall to 2.8 percent.

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The F-statistic for the regression was 4.1 indicating overall significance at the 95 percent level, which is the usual level economists look for to be confident of a solid relationship. The T-statistic on the government spending variable was 2.0, which indicates significance at over 95 percent. (Note that the statistical results were even stronger when I included data back to 1946 because post-war government cuts coincided with robust economic growth.)

The R-square of the regression was low, indicating that changes in government spending only explained a small portion of current-year GDP growth. That makes sense because a myriad of other factors affect GDP growth, including economic growth in other countries, regulatory factors, oil industry shocks, technology shocks, etc.

Note that my explanatory variable was total government spending, which includes government production and government transfers. I think that both types of government spending harm the private economy. If the government increases UI payments or food stamps, for example, it induces fewer people to work.

Personally, I’m suspicious of statistical “proofs” of economic relationships. But I do think that even broad-brush results such as this should give pause to the reporters and policy wonks who often write articles with hidden Keynesian assumptions. I think that the harm from increasing government spending affects the economy over a longer period of time. But even these single-year regression results suggest that people should be skeptical of the widely held notion that the economy is like a car and the government can speed things up by simply stepping down on the spending gas peddle.

P.S. I’m happy to share my data upon request if people want to check for any Reinhart-Rogoff problems.

April 30, 2013 3:41PM

The Pentagon as a Jobs Program

One of the realizations that helped me to dispense of the neoconish foreign policy views of my youth is that for federal policymakers, the Pentagon is like a giant jobs program. Regardless of need, a military installation or armament factory can generally count on the unwavering support of the member of Congress who represents the district or state where the facility is located. 

On Monday, the Associated Press’s Richard Lardner provided a textbook example: over the past two years Congress has spent almost a half billion taxpayer dollars—and wants to spend another $436 million—upgrading Abrams tanks that experts and the Army itself say aren’t needed.

Who are some of the biggest congressional backers of the tank upgrading? Why, Republican “deficit hawks”! 

Keeping the Abrams production line rolling protects businesses and good paying jobs in congressional districts where the tank's many suppliers are located. 

If there's a home of the Abrams, it's politically important Ohio. The nation's only tank plant is in Lima. So it's no coincidence that the champions for more tanks are Rep. Jim Jordan and Sen. Rob Portman, two of Capitol's Hill most prominent deficit hawks, as well as Democratic Sen. Sherrod Brown. They said their support is rooted in protecting national security, not in pork-barrel politics. 

“The one area where we are supposed to spend taxpayer money is in defense of the country,” said Jordan, whose district in the northwest part of the state includes the tank plant.

Ah, yes, the “national security” excuse—probably the most cited justification by politicians to spend other people’s money since the ink dried on the Constitution.        

Remove the flag that politicians like to wrap themselves in and it becomes pretty obvious that crass pork-barreling is the big motivator. Defense contractors know the score, which is why work is farmed out to subcontractors in numerous states and districts: 

The Lima plant is a study in how federal dollars affect local communities, which in turn hold tight to the federal dollars. The facility is owned by the federal government but operated by the land systems division of General Dynamics, a major defense contractor that spent close to $11 million last year on lobbying, according to the nonpartisan Center for Responsive Politics… 

The first editions of the Abrams tank were fielded in the early 1980s. Over the decades, the Abrams supply chain has become embedded in communities across the country. 

General Dynamics estimated in 2011 that there were more than 560 subcontractors throughout the country involved in the Abrams program and that they employed as many as 18,000 people. More than 40 of the companies are in Pennsylvania, according to Sen. Robert Casey, D-Pa., also a staunch backer of continued tank production. 

A letter signed by 173 Democratic and Republican members of the House last year and sent to then-Defense Secretary Leon Panetta demonstrated the depth of bipartisan support for the Abrams program on Capitol Hill. They chided the Obama administration for neglecting the industrial base and proposing to terminate tank production in the United States for the first time since World War II. 

This is why U.S. taxpayers are subsidizing the security of wealthy allies

April 30, 2013 10:40AM

How to Engage with Cato on Social Media

In case you haven't been following what the Cato Institute has been doing lately on social media, here's an accessible list of all of Cato's current projects across different social media platforms:






P.S.: Today is my last day leading social media and digital outreach efforts at Cato. Congratulations to my successor, Kat Murti, who will be taking Cato into the future and helping grow Cato's social media following to new heights.

April 30, 2013 8:50AM

Obama’s New Transportation Chief Wants Streetcars for Everyone

America's transportation system will continue to grind to a halt under President Obama's pick for transportation secretary, Anthony Foxx. Currently mayor of Charlotte, N.C., Foxx strongly supports streetcars and other obsolete forms of transit.

It is a measure of the glacial pace of America's political system that Obama had nearly 16 months' notice that current Secretary Ray LaHood planned to step down at the end of Obama's first term, yet the president required another three months before finding a replacement. If the administration has anything to say about it, American travelers will move at the same glacial pace: the streetcars that Obama, LaHood, and Foxx want to fund are slower than most people can walk.

Transit advocates often point to Charlotte as an example of a successful lightrail line (more accurately described as a "low-capacity-rail line"). With success like this, I'd hate to see failure: the line cost more than twice the original projection; generates just $3 million in annual fares against more than $20 million in annual operations and maintenance costs; and collects of an average of just 77 cents per ride compared with nearly a dollar for other light-rail lines. Now Charlotte wants to extend the line even though a traffic analysis report predicts that the extension will dramatically increase traffic congestion in the corridor (see pp. 54-56).

Foxx believes rail transit "drives economic development," says George Washington University Professor Christopher Leinberger approvingly. "The goal of any transportation system, especially rail transit, is not to move people," Leinberger argues. "The goal is economic development at the stations."

Anthony Foxx certainly believes that. "If we didn't do streetcar," he asked the Charlotte city council during a debate, "does anybody have an idea how we're going to revitalize" downtown Charlotte?

Rail advocates claim that Charlotte's low-capacity-rail line helped revitalize neighborhoods along the line. However, a study by transportation expert David Hartgen concluded that most of the billions of dollars of development that was planned along the line was never built. Of the developments that were built, most would have taken place without the line, Hartgen found, though not necessarily in exactly the same locations.

I've said this before and I'll say it again: transportation spending generates true economic growth only if it results in lower-cost, faster, and/or more convenient movement of people and goods. Streetcars and low-capacity rail are more expensive, slower, and for all but a tiny number of people less convenient than the alternatives, whether buses or cars. Even if you reduce transit rider costs by subsidizing them to the hilt, someone has to pay the subsidies and that slows economic growth.

Foxx is blissfully unaware of this and we can expect him to continue LaHood's policy of giving away as much money as possible for transit projects that are as expensive as possible and move few people while creating more congestion for everyone else.

April 29, 2013 2:37PM

More Questions for Secretary Sebelius

Given the growing concern even among Democrats that ObamaCare will result in a "huge train wreck" later this year, I have a few questions for Health and Human Services Secretary Kathleen Sebelius to add to my previous list:

  1. What happens if a federal court (say, the Eastern District of Oklahoma) issues an injunction barring HHS from making "advance payments of tax credits" in the 33 states with federal Exchanges?
  2. Has HHS done any planning for that contingency? If so, what are those contingency plans?
  3. If HHS has not, why not? Given that the Congressional Research Service and Harvard Law Review both say there's a credible case that the PPACA forbids tax credits in the 33 states with federal Exchanges, how could HHS not have a contingency plan ready?

For more on how HHS is violating federal law by planning to issue advance payments of tax credits through federal Exchanges, read my Cato white paper, "50 Vetoes: How States Can Stop the Obama Health Care Law," and my Health Matrix article (with Jonathan Adler), "Taxation Without Representation: The Illegal IRS Rule to Expand Tax Credits Under the PPACA."

April 29, 2013 2:36PM

The American Roots of Tax Aversion

In last Sunday's Washington Post, Jennifer Rubin wrote that Republicans must move beyond their adoration of Ronald Reagan and recognize, among other modernizations, that

America will not return to the pre-New Deal era. Limited government, not small government, must be the aim. That requires low taxes, not taxes that never increase.

She wants Republicans to give up "the pledge" and be willing to raise taxes if that's the prudent thing in any circumstance.

Republicans and conservatives and libertarians who don't want to follow her advice could find some historical support just a few inches away on the same page of the "Outlook" section. Reviewer Walter Isaacson quotes this line from a new book on the origins of the Boston Tea Party and the American Revolution, Bunker Hill by Nathaniel Philbrick:

Rather than propose a means of raising revenue that they deemed fair, the colonials were more than happy to direct their considerable energies toward opposing whatever plan the British ministry put forward.

That is, the American revolutionaries didn't feel obligated to help the British government raise all the money it wanted. They were satisfied to oppose what they regarded as unwarranted taxation.

Tax resistance: an American tradition since 1773. Or 1767. Or 1687.

April 29, 2013 12:53PM

What to Do about OPEC?

Cato hosted a policy forum last week (which you can watch in its entirety if you missed it the first time around) to discuss a new paper released by Security America’s Energy Future (SAFE).  The paper – written by long-time friends Andy Morriss and Roger Meiners – argues that there is a consensus among academics who have studied OPEC.  The consensus?  The cartel is responsible for less crude oil on the market than would otherwise be the case (which means higher prices than would otherwise be the case) and for the bulk of the price volatility we find in crude oil and, thus, gasoline markets.  “The international market for oil is not a free market” they conclude.  “The global oil market deviates in important ways from the competitive model and that these market anomalies have significant economic impacts and so are relevant for policy makers.”

While Morriss and Meiners would thus seem to invite politicians to act, they offered no agenda of their own.  That’s where SAFE comes in.  FedEx’s Fred Smith, who co-chairs SAFE’s Energy Security Leadership Council, argued at the forum that the federal government needs to respond to OPEC’s machinations by (1) achieving energy independence for North America (a goal I’ve been quite skeptical about in the past), (2) establishing tough energy efficiency standards for a whole host of goods, but most particularly, for U.S. automobiles via CAFÉ standards (an agenda that most economists would reject in favor of accurate price signals), and (3) subsidizing R&D in order to find alternatives to oil in transportation markets.  SAFE discusses this agenda more robustly in their “National Energy Strategy for Energy Security, 2013”.

SMU’s James Smith – one of the most prominent energy economists who works in this field – was on-hand to offer what I think was a compelling rebuttal to the central arguments forwarded by the Morriss and Meiners study.

Smith argued that, contrary to Morriss and Meiners, there is simply no consensus in the literature about what impact, if any, OPEC has on the world crude oil market.  One can find empirical analyses demonstrating that the cartel has zero impact on crude oil prices and production relative to what would be the case absent the cartel; that it’s not the cartel per se but Saudi Arabia that exercises the market power at issue; and that the cartel does indeed restrain production but not in the manner popularly thought.  That is, the production restraint is primarily in the form of underinvestment in upstream production capacity, not in cutting back production at opportune times to drive up prices.  Which of these narratives – if any – is closest to the truth is, according to Smith, unclear despite 40 years of serious study.  While most academic observers probably believe that OPEC does indeed restrain production below what a perfectly competitive free market might yield, they can’t conclusively prove it.

Smith further argued that oil price volatility has little to do with the cartel; it has to do with relatively inelastic supply and demand.  Small changes in supply or demand have a major impact on crude oil prices with or without the cartel, and those “small changes” happen all the time.  To illustrate his point, he noted that natural gas markets, which have similarly (relatively) inelastic supply and demand, yield gas prices that are even more volatile than oil prices … and there’s certainly no “gas cartel” that one can blame for that.

Smith concluded with a powerful point: if a cartel exists and successfully reduces supply, the cartel members will enjoy excess profits, or “rents” in the jargon of economists.  Should those rents go instead to consumers?  As consumers, of course, we think that it is unfair that the rents (the difference between the world crude oil price and the cost of production plus a normal profit margin) are denied us.  But beyond the fact that we benefit, is there any objective reason to believe that our claim to those rents are morally stronger than the producers’?

Cato adjunct scholar Richard Gordon offers the most powerful response to the Morriss & Meiners paper; “so what?” Whether we like or not, OPEC exists, it has market power, and it is in their rational self-interest to use it. Given that we cannot change those facts, how can we best respond?  By leaving the market alone.  OPEC-driven oil scarcity will produce higher prices which will, in turn, induce the necessary amount of non-OPEC exploration and production, energy conservation, and investment in alternative fuels.  Market actors – if they choose – can hedge against price volatility by signing fixed price, long-term contracts, by taking positions in the futures market, or by investing in energy efficiency.  The contention that government will act more efficiently in these pursuits than will the market only holds (maybe) if we can find significant market failures in non-OPEC oil and gas production, energy consumption, or alternative fuel markets … and we cannot.

Unfortunately, these issues are muddied by statements such as Morriss’ and Meiner’s contention that “The international market for oil is not a free market.”  This is the standard cry of those who wish to justify intervention.  After all, if it’s not a free market, leaving it alone does not yield efficiency; only intervention – ideally, to make it a free market, or less ideally, to dictate energy production and consumption patterns reflecting what we think would follow from an OPEC-free market – can hope to do that.  But think about it.  The international oil market is extremely competitive.  Price signals change minute by minute and quite accurately reflect variations in supply and demand.  At worst, the market simply has less oil to distribute because OPEC holds back production.  The market qua market, however, works fine.