Why government spending does not stimulate economic growth

In a throwback to the 1930s and 1970s, Democratic lawmakers in the US are betting that the country’s economic ills can be cured by an extraordinary expansion of government, says Brian M. Riedl, the Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at the Heritage Foundation.

This approach has already failed repeatedly in the past year, in which Congress and the President:

Increased total federal spending by 11 per cent to nearly $3 trillion.

Enacted $333 billion in "emergency" spending.

Enacted $105 billion in tax rebates.

Pushed the budget deficit to $455 billion in the name of "stimulus."

Every one of these policies failed to increase economic growth. Now, in addition to passing a $700 billion financial sector rescue package, lawmakers have decided to double down on these failed spending policies by proposing a $300 billion economic stimulus bill. Even though the last $455 billion in Keynesian deficit spending failed to help the economy, lawmakers seem to have convinced themselves that the next $300 billion will succeed, says Riedl.

This is not the first time government expansions have failed to produce economic growth. Massive spending hikes in the 1930s, 1960s, and 1970s all failed to increase economic growth rates. Yet in the 1980s and 1990s – when the federal government shrank by one-fifth as a percentage of gross domestic product (GDP) – the U.S. economy enjoyed its greatest expansion to date.

Cross-national comparisons yield the same result. The U.S. government spends significantly less than the 15 pre-2004 European Union nations, and yet enjoys 40 per cent larger per capita GDP, 50 per cent faster economic growth rates, and a substantially lower unemployment rate, says Riedl.

When conventional economic wisdom repeatedly fails, it becomes necessary to revisit that conventional wisdom. Government spending fails to stimulate economic growth because every dollar Congress "injects" into the economy must first be taxed or borrowed out of the economy. Thus, government spending "stimulus" merely redistributes existing income, doing nothing to increase productivity or employment, and therefore nothing to create additional income. Even worse, many federal expenditures weaken the private sector by directing resources toward less productive uses and thus impede income growth, says Riedl.

Source: Brian M. Riedl, Why Government Spending Does Not Stimulate Economic Growth, Heritage Foundation, Backgrounder No. 2208, November 12, 2008.

For text: http://www.heritage.org/Research/Budget/bg2208.cfm

For more on Federal Spending & Budget Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=25

FMF Policy Bulletin/ 18 November 2008