Tag Archives: government spending

Fiscal Drag Continues to Pull Down the Economy

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Private employment, government employment, December 2010 to May 2012

A pair of disappointing reports, from this morning (June 1) and yesterday (May 31), indicate that the economy continues to grow only slowly, with consequent slow growth in employment and indeed a small rise in the rate of unemployment to 8.2% from 8.1% last month.  Posts on this blog in January, on GDP growth and on employment, had flagged that growth, which at that time appeared to be improving, could well fall back in 2012.  Unfortunately, that appears to be happening.  Cut-backs in government spending account for a major part of that disappointing growth.

The Bureau of Labor Statistics, in its June 1 release this morning on employment, found that total US employment grew in May by a net 69,000 jobs, with an increase of 82,000 private jobs and a fall of 13,000 government jobs.  Based on the growth rate of the labor force over the ten year period of 2002 to 2012 (there is a good deal of fluctuation in monthly figures), the labor force is growing at about 83,000 workers per month on average.  Employment growth in May of just 69,000 jobs does not keep up with this, much less make a dent in the still high unemployment.

The figures released this morning were also disappointing in the revised numbers they showed for April.  Last month, the initial estimates were that April total employment had risen by 115,000 jobs, with private jobs growing by 130,000.  These were already not good, but the revised estimates issued this morning based on more complete data indicate total jobs in April grew by only 77,000 jobs, with private jobs growing by just 87,000 jobs.  With the May numbers of 69,000 and 82,000 for total and private jobs, respectively, we now have two months of disappointing job growth.  Unless the May numbers are significantly revised when more complete data becomes available, we cannot say that this is only a one month fluke.

As one can note from these numbers, private job growth has been consistently above total job growth.  That is because government continues to cut back on the number of workers it employs, despite assertions by Mitt Romney and other Republicans that government has been growing.  The graph above shows the monthly changes in employment of both private and government employees over the last year and a half, where one sees that government employment has been falling in all but two of these months.  Note that the government figures in the graph are for total government, including at the state and local level.  But the underlying figures show that the fall has been in employment both at the federal and at the state and local levels.

This steady fall in government employment depresses overall job growth, and adds up over time.  Between January 2009, when Obama was inaugurated, and May 2012, total government jobs fell by 607,000.  In contrast, over January 2005 and May 2008, the comparable period in Bush’s second term, total government employment rose by 743,000.  If government employment had been allowed to grow as much during the Obama period as it had during the Bush period, the difference would have been an additional 1.35 million jobs.   This difference alone would have brought the unemployment rate down from the current 8.2%, to just 7.3%.  But one would expect with the still depressed economy, with unemployment high, that increased government employment would have spurred some private job growth.  Assuming conservatively a multiplier of two (i.e. there would be one additional private job for each additional government job, to produce what the now employed government workers will spend on), the unemployment rate would have dropped to just 6.5%.

That is, had government employment been allowed to grow during the Obama period by as much as it had during the comparable Bush period, unemployment would have dropped to 6.5%.  With full employment generally considered to be in the range of 5 to 6% currently, this would have brought employment most of the way to full employment.

The other disappointing report was on estimated GDP growth in the first quarter of 2012, released by the Bureau of Economic Analysis on May 31.  This was the regular first revision of the initial estimate of GDP growth that had been released a month ago.  The initial estimate of GDP growth in the first quarter of 2012 was discussed in a posting on this blog in April.  The initial estimate was that GDP had grown at a 2.2% annualized rate in the first quarter.  This estimate has now been revised downward to 1.9%.

The revision is not large, but is not in a good direction.  And it is interesting to note that two-thirds of that downward change (0.2% points of the 0.3% points reduction) was due to a downward revised figure on government spending.  Government spending was already falling, and the initial estimate, discussed in the blog post cited above, was that it took 0.6% points away from what GDP growth would have been.  The revised estimate increases that reduction to 0.8% points of GDP.  Government spending on goods and services (for all government, including state and local) is estimated to have declined at an annualized rate of 3.9% in the first quarter, similar to the 4.2% rate fall in the fourth quarter of 2011.

The reduction in government demand for goods and services leads to a reduction in GDP in present circumstances since unemployment is high, there is substantial excess capacity, and hence goods and services produced for sale to government will not come from goods and services that could be sold elsewhere.  There is plenty of capacity to produce whatever people demand, and the problem is there is no demand for additional goods and services to be sold elsewhere.

This fall in government spending, especially in the last half year (i.e. the fourth quarter of 2011 and the first quarter of 2012), can explain a large part of the recent slow growth.  As noted above, the revised GDP estimates indicate that the fall in government spending in the first quarter of 2012 subtracted 0.8% points from what GDP growth would have been.  There was a similar 0.8% point reduction in the fourth quarter of 2011.

But far from simply not falling, government spending will grow in a normally growing economy.  Hence the basis of comparison should not be to zero government spending growth, but rather something positive.  One comparison to use would be the growth seen during the Bush administration.  Over 2001 to 2008, government spending growth on average accounted for 0.42% points of GDP growth at an annualized rate.  Keep in mind that this spending growth is for all government, not simply federal spending (which was high), but also state and local government spending.  Also, government spending in the GDP accounts is for direct goods and services only, and excludes spending via transfers (such as Social Security).

Finally, government spending growth in periods such as now, when unemployment is high and there is excess capacity, will have a multiplier impact, for the reasons discussed above.  A reasonable and conservative multiplier to use would be a multiplier of two.

The table below summarizes the impact of these assumptions for what growth would have been in 2011Q4 and 2012Q1:

      Annualized growth rate of GDP 2011Q4 2012Q1
GDP Growth Observed 3.0 1.9
GDP Growth if Government had not contracted 3.8 2.6
GDP Growth if Government had grown at the Bush rate 4.2 3.1
GDP Growth if Government had grown at the Bush rate, with a multiplier of two 5.5 4.3

GDP growth as actually happened was at a 3.0% rate in the fourth quarter of 2011 and 1.9% in the first quarter of 2012.  Had reductions in government spending not taken away 0.8% points from these growth rates in each of these two periods, growth would have been 3.8% and 2.6% respectively.  But this implicitly places government spending growth at zero.  Had government been allowed to grow as it had between 2001 and 2008 during the Bush terms, growth would have been 4.2% and 3.1% even with no multiplier.  With a multiplier of two, the rates would have been 5.5% and 4.3% respectively.

Such growth rates of about 5% on average is what the economy needs if it is to recover.  At 2% or so, growth is insufficient to create sufficient demand for labor to bring down unemployment on a sustainable basis, as we have just seen in the report this morning.  And a 2% growth rate is so modest that it is vulnerable to shocks, such as from Europe (where Germany and the EU still have not addressed what needs to be done to resolve the Euro crisis), or from a spike in oil prices (should the Iran situation blow up, literally), or even from swings in inventories (as discussed before in this blog).

With government contracting as it has, despite the high unemployment and excess capacity, fiscal drag is acting as a severe constraint on economic growth.  There is a not a small danger that growth could slip back to negative rates, and that is not good for an incumbent President in an election year.

Federal Government Expenditures Under Obama: Close to Flat, in Contrast to the Big Increases of His Republican Predecessors

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Federal Government Budget Real Expenditures, Government Outlays, Reagan, Bush Sr., Clinton, Bush, Jr., Obama

There is perhaps no more firmly held view in Republican (and especially Tea Party) circles than that federal government expenditures have exploded under Obama.  But it is simply not true.  Previous analysis in this blog has shown that total government expenditures (including state and local) traced over the course of each business cycle in the US since the mid-1970s, rose less during the Obama period than in any of the others.  Indeed, that analysis indicated that if government spending under Obama had been allowed to increase as much as it did under Reagan following the 1981 downturn, then we would now likely be at or close to full employment.

But when President Obama noted in a speech in Iowa on May 24 that the pace of federal spending had grown at the slowest pace in his term of any presidency in sixty years, the remarks were met with widespread incredulity in the press and on the internet.  Given the repeated Republican attacks asserting the opposite, many did not believe it could be true.

But it is true.  The graph above shows the levels of real federal spending in the first terms (and Bush’s second term) of each president since Reagan.  Growth in real federal spending in each presidential term prior to that was also higher than under Obama, going back to Eisenhower.  (Under Eisenhower there was a fall in real spending, as Korean War expenditures, at a peak when he took office, came down as the war ended.  There was an even larger fall during the Truman term as World War II came to an end.  But these cases are not terribly relevant.)

The figure above shows real federal spending levels in each presidential term since Reagan, indexed with the year preceding their first budget set equal to 100, and then showing the levels in real (inflation-adjusted) terms for the four budget years of their presidencies.  Only the first terms are shown for two term presidents other than Bush Jr., to make it comparable to the Obama term thus far, to reduce clutter in the figure, and because it made no real difference (increases during the second Reagan and Clinton terms were in the middle of the ranges shown above, with four-year increases of 7% and 8% respectively).

Federal government spending under Obama has been largely flat, increasing by less than a total of only 3% in real terms by his fourth budget year (FY13, where I used the budget proposal made to Congress in February by Obama for this figure; any actions by Congress will likely result in further cuts, not increases, in this).  The only recent president with spending at all close to this was Clinton in his first term, when spending rose by a total of 4% in real terms.  The biggest spending increases by far were by Bush, Jr., in both his first and second terms.  Real spending rose by 19% in Bush’s first term, and by 24% in his second term (even adjusting for spending approved as part of the FY09 Stimulus package:  see the technical note below).  Reagan, revered for his small government conservatism, oversaw an increase of 14% in real government spending during his first term.

The Democratic presidents Obama and Clinton have therefore kept federal government spending tightly under control, while the Republican presidents of Reagan and especially Bush, Jr., oversaw large expansions in real federal spending.  Obama’s conservatism on this has certainly hurt the economy at a time when unemployment remains high due to a lack of demand in the aggregate for what such labor could produce.  But he has been criticized, without any basis in fact, for the opposite.

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Technical Note

It is important to be aware that budget (or fiscal) years do not coincide with presidential terms.  Presidents are inaugurated in January, while budget years start in October.  A president therefore takes office with a budget year already one-third over, Congressional appropriations already set (or at least largely set), and little ability, with rare exceptions, to influence spending in the year they take office.

Thus in the figure above, the base year of expenditures (set equal to 100) will be the budget year in the middle of which a president took office, and the final year will be the budget year underway at the end of his term.  The figures are calculated from data in the Historical Tables issued by the Office of Management and Budget.

The one exception where a president has had a major impact on spending levels in his first year would be spending under the Stimulus package that Obama signed into law, which was approved on February 17, 2009.  This package provided for a total of $971 billion in measures, but $420 billion of this was for tax cuts, and $551 billion for spending.  Of this $551 billion in spending, only $114 billion (according to the most recent estimates of the Congressional Budget Office) was spent in FY2009, approximately as planned.  The figure above adjusts for this, with the $114 billion (equal to $103 billion in 2005 prices) taken out of the fourth year of the Bush second term expenditures, and with the same amount also used to adjust the base year of the Obama expenditures.  Without these adjustments, federal government expenditures in the Bush second term would have gone up by a total of 28% (rather than 24%), and Obama’s expenditures by his fourth year would have declined by 0.5% (rather than increasing by 3%).

The US Personal Savings Rate: A Recent Fall, but Still Well Above the Rate of a Few Years Ago

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US personal savings rates, 1950 to 2012, US personal savings as a percentage of disposable personal income

In a posting yesterday on this blog on the initial GDP estimates for the first quarter of 2012, I noted that GDP growth had slowed further (to just 2.2%) from a rate that was already less than what it needs to be in a recovery.  The primary reason for this slow growth was the continued cuts (yes cuts, despite what Romney has been saying) in government expenditures, which reduced GDP growth by 0.6% points from what it otherwise would have been.  The cuts in government expenditures are now at the federal level in addition to cuts at the state and local level, and they act as a substantial drag on demand for production.  GDP growth also decelerated, although to a lesser extent, due to a fall in business fixed investment (which reduced GDP growth by 0.2% points for what it would otherwise have been).

The primary bright spot in the new numbers was the acceleration in growth of personal consumption expenditure, which grew at a 2.9% rate and accounted for 2.0% points of the GDP growth, and especially the growth of residential fixed investment (housing construction primarily), which grew at a 19.1% rate and added 0.4% points to growth.

Some observers of this data also noted that the figure for the personal savings rate declined in the quarter, as personal consumption rose at a faster rate than personal income.  This is correct, and there is therefore the concern whether personal consumption will be able to continue to grow at the rate it did in the first quarter.  Specifically, the personal savings rate was 4.5% in the fourth quarter of 2011, and this fell to 3.9% in the first quarter of 2012.  If personal consumption expenditure will end up being forced down as households seek to keep savings at some level, the primary support to recent growth of GDP will be lost.  Coupled with the political pressure from Republicans and other conservatives to keep cutting government expenditures further, and with weak business investment due to the still high excess capacity in the economy and weak demand for production, growth could slow further and perhaps drop down into negative territory and thus into a new recession.

The question then is whether the reduction in the savings rate to 3.9% from 4.5% in the previous quarter may lead to pressure on households to reverse this and start saving more, and hence end up cutting personal consumption.  This is indeed possible, and the consequence could then be slower growth if government remains constrained in what it is allowed to spend.  It is not really possible to predict with any confidence whether this will happen, but it is useful to put the reduction in savings to 3.9% this past quarter in a longer term context, to see where it now stands compared to what it has been in the past.

The diagram above does this, showing the personal savings rate in the national income accounts going back all the way to 1950.  The data comes from the GDP and Personal Income Accounts of the Bureau of Economic Analysis.  The lines in red show the trends, and are simply hand-drawn to make the trends easier to discern.  What is interesting is how the person savings rate trended upwards from 1950 to the early 1980s, rising from roughly 7 to 8%, to around 10 to 11% (although with a good deal of short-term variation around the trend rate in these quarterly numbers).  But then the trend shifted to a steady fall, bringing the personal savings rate to just 1 to 2% by around 2005.  Savings then jumped to around 5 to 6% at the time of the economic and financial collapse in 2008, and has then come down some, to the current 3.9%.  It is too soon to tell where the recent fluctuations since the trough in 2005 will lead, and what the new trend, if any, will be.

A careful analysis that might explain why the personal savings rate has varied in the way it has in the post-World War II period is beyond the scope of this note.  But a good hypothesis would be that the shift to a strong downward trend since the early 1980s is related to changes brought in by Reagan, and in particular due to the deregulation of the financial markets that started then.  As a consequence of regulatory and other changes of the period, it became easier for banks to provide home equity loans to households, with only a second lien on the homes backing these credit lines.  As a result, home equity loans exploded, from just $1 billion outstanding in 1982 to $100 billion in 1988 (these figures are from a New York Times article describing the early growth and the impact of advertising in encouraging this), to $215 billion in 1990, $408 billion in 2000, and $1.1 trillion in 2006.  The market then finally stabilized, started to fall in 2009, and by 2011 the outstanding was $873 billion (the figures since 1990 are from the US Fed; its series on home equity credit lines do not go back further than 1990).  There were also other regulatory and consequent institutional changes in the credit markets during this period, which made it easier for households to borrow.

As households found it possible to borrow against their home equity values, during a period when house prices rose and then soared, it was possible for households to spend on consumption beyond what their current income alone would allow.  Some households thus had negative savings, some had low savings, and averaged across all households, savings rates fell.  This is what one sees in the graph above.

This all ended with the 2008 collapse, and indeed the housing bubble was already starting to deflate earlier, as the housing peak was in 2006 (see my blog posting here).  Home prices collapsed, there was no home equity to borrow against, spending in excess of income could not be done, and the average savings rate then rose.  With the crisis now easing and with credit slowly becoming more available, it is not yet clear whether savings rates will fall back down to where they were in the decade prior to 2008, or whether they will remain roughly where they have been since 2008, or indeed whether they will rise back to where they were before Reagan.

Savings rates more like what they have been in recent years, and indeed higher than that and back to where they were prior the changes launched by Reagan, will be important for the long-term health of the US economy.  Investment needs to be higher, while the US international deficits (the trade and current account deficits) need to be smaller.  This can only happen with higher savings.  But higher savings in the near term, when the economy remains weak and with government constrained by Republican opposition in what it is allowed to spend, will lead to even slower GDP growth.  Finding the right path through this will be tricky.