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Low Government Spending, High GDP Growth?

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If you read the current debates about government spending, you’re certainly aware that the top issue right now is –  Should European nations continue to pursue a balanced budget (as the Germans suggest)?

Germany answers yes.  France and other EU members say no.

The evidence, at least so far, supports the Germans.

The Government Spending Academics

The debate in Europe is, of course, broader than just Europe.

On the one side of the debate are government and academic economists who argue that reducing government spending is sending European economies into a recession.

Individuals with this form of naivety generally think that the “multiplier” effect of government spending is high (regardless of the evidence).

What is meant by “multiplier” is that individuals with this view think that sending out government checks induces firms to increase hiring.  They point to, for example, governments outsourcing the building of railways or other infrastructure.  It’s easy to “prove” that private businesses are hiring individuals to build the given infrastructure project.

GDP – The Government Spending Realists

On the other side of the debate are what can be classified as “government spending realists.”  They look at correlations, causation, incentives, and the entire economic situation to assess the effects of government spending.

They readily point out that, at times, government spending can have a small positive effect on economic growth, but also acknowledge the limitations of always turning to government spending to “improve” economic growth.

Overall, government spending realists generally see government spending as something to be minimized when possible (even if politically unpopular).

GDP – What Does the Evidence Show?  A Look at the Government Spending Side.

With the long-standing debate as the background, what does recent evidence show?

Here’s the answer when looking at western nations (mostly out of the European Union).

The first graphic is a look at government spending growth since 2009 (most governments across the globe had gigantic jumps in government balance sheets following the onset of the global financial crisis).

The largest spender from January 2009 to October 2014 is the Italian government, up 73%.  Other big spenders over the same period include Finland (72%), Belgium (32%), Luxembourg (29%), and Spain (22%).

On the other side, the more reasonable government spenders (perhaps too much for one nation) include Greece (down 39%), Switzerland (down 3%), Netherlands (up 1%), Ireland (up 4%), Germany (up 8%), Denmark (up 8%), the U.K. (up 10%), and Sweden (up 13%).

Simply out of interest, following the table view are 3 dashboards looking at what 16 so-called “advanced economies” have done with check writing over the past few years.

Growth in Government Spending since 2009

Government Spending Dashboard1 Government Spending Dashboard2 Government Spending Dashboard3

What Does the Evidence Show?  A Look at GDP Growth.

GDP is the broadest measure of economic growth.  It is also what academics try to connect government spending to when estimating what the government spending multiplier might be.

Here’s what GDP growth has done over the past few years.

The best performing so-called “advanced economy” is Australia, up 20%.  Rounding out the top 5 includes Canada (12%), Switzerland (11%), the U.S. (9%), and Sweden (7%).

On the other end, the countries the worst performance of economic growth include Greece (-25%), Italy (-9%), Portugal (-6%), Spain (-4%), and Finland (-3%).

Growth in GDP since 2007 by Nation

Connecting the Two: Government Spending and GDP Growth

Do you see a relationship between the two?  Have nations with expanding government balance sheets outperformed nations with declining government balance sheets?

The accurate answer is no, there’s no correlation.

Take, for instance, Italy, which has seen the largest expansion in government spending while performing the second worst.

On the flip side, Greece has reduced government spending the most and has also experienced the worst economic performance.

The contradictions continue. Switzerland, which over the period covered has reduced government expenditures second most (down 3%) has experienced the third best economic performance.

Finland, with the second largest increase in government spending, has experienced the the fifth worst economic performance of the economies listed.

If this were an academic paper, the next step would be to present scatterplots, panel regressions, and other econometric evidence.  What it would show is exactly what the realists point out – government spending is not the cause of poor European economic performance.

GDP and Conclusion

Overall, although politicians and government spending advocates (which includes almost all academic and government economists) are simply wrong when they say government spending is the answer to poor economic growth.  Individuals with this view should expand their horizon beyond who pays their paychecks, and look at how business actually works, which includes looking at tax incentives, productivity, and the competitive position of firms operating within certain geographic areas’ borders.

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Sheeraz Raza

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