March 20, 2023

Economix Blog: The Role of Austerity



Thoughts on the economic scene.

The chart here offers one of the better recent snapshots of the American economy that you will find.

The blue line shows the rate at which the government — federal, state and local — has been growing or shrinking. The red line shows the same for the private sector.

Annualized growth in the public and private sectors.Source: Bureau of Economic Analysis, via Haver AnalyticsQuarterly change at seasonally adjusted annual rate.

The brief version of the story is that the government, which helped mitigate the recession, has been a significant drag on growth for more than a year now.

In 2007, both the private sector and government were growing. The government continued growing through 2008 and most of 2009, with the exception of one quarter when military spending fell. The private sector, though, began to shrink in 2008 and by late 2008, as the financial crisis took hold, it was shrinking rapidly.

The government — first the Federal Reserve and the Bush administration and then, more aggressively, the Fed and the Obama administration — responded with various stimulus programs. They are the reason for the blue line’s upward spike in 2009.

The private sector began to recover in 2009. The recovery slowed in 2010 and again in 2011, as the dips in the red line show. But by the end of last year, the private sector was expanding at a healthy 4.5 percent annualized pace.

Why, then, wasn’t economic growth in the most recent quarter better than the 2.8 percent that the Commerce Department reported today?

Because the economy is the combination of the private and public sectors. The public sector has been shrinking for the last year and a half — mostly because of cuts in state and local government, with some federal cuts, especially to the military, playing a role as well. In the fourth quarter, government shrank at an annual rate of 4.5 percent.

Over the last two years, the private sector grew at an average annual rate of 3.2 percent, while the government shrank at an annual rate of 1.4 percent.

The combined result has been economic growth of 2.3 percent.

People can obviously have a spirited debate about cause and effect here. I’m not aware of much research or evidence suggesting that short-term declines in government activity — at least in a largely free-market economy — cause short-term growth in the private sector.

Lacking such evidence, the obvious conclusion seems to be that economic growth, and employment growth, would have been significantly stronger over the last two years without government cuts. But I’d invite readers to point us to any research that bears on the question, one way or the other.

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