Is the Economy Growing? Government Spending Distorts GDP Measurements


You may have heard various news stories claiming that GDP growth proves the economy is improving, but what does GDP actually measure? At a high level, the GDP metric is basically calculated like this:

GDP = private consumption + gross investment + government spending + (exports − imports)

The important thing to keep in mind is that all government spending is included in this metric as being a good thing. In other words, no matter what the government is spending money on, the GDP formula automatically assumes that such spending is a driver of economic growth.

To demonstrate this point, let us assume that a country's economy produces 1,000 units of steel a year. Now assume that the state decides it is going to purchase an aircraft carrier that will consume 100 units of steel. Wait, how does this aircraft carrier purchase constitute "economic growth?"

The steel would have been put to use by industrial manufacturers in the private sector if the state had not purchased the steel for the carrier. Of course, in order for the state to purchase the steel it must first either rob the public directly through taxes or borrow/print the money it requires.  Either way, the purchase of a carrier by the state makes everything else that uses steel more expensive; it  furthermore directly deprives the public of enjoying more consumer goods.

Before the state decided to build the carrier, industrial manufacturers were bidding on 1,000 units of available steel. But after the purchase, private industry got only 900 units of available steel. 

The market rations scarce goods through the price system, so the cost of all goods that use steel will increase. Obviously, the government is not hindered by something as trivial as high prices since it has a printing press at its disposal. Since the state is not limited by profits or losses, it is directly responsible for driving private consumer goods industries out of business when it bids up the price of resources through its spending.

None of this is reflected in the GDP metric.

Consider that if the government was responsible for 100% of the nation's spending, our present GDP figures wouldn't change at all, but the economy would produce nothing of consumer value.  

Inevitably, any job that is created by the state leads to unsustainable waste because none of the jobs that it creates are subject to market-driven profit and loss tests. If a job was truly sustainable, the private sector would already be doing it for a profit.

The U.S. government is currently responsible for a whopping 40% of GDP spending. Keeping my aircraft carrier example in mind, I hope you can see that when roughly half of spending is a function of government, it means there are very few people left building things that actually improve the human condition within the economy.

The government can only get away with this wild amount of spending for as long as other countries are willing to sell us their "stuff" in exchange for dollars. The high percentage of GDP spending by the state is directly reflected in the large trade deficits that the U.S. runs with other countries. Because the state has bought up resources for its own ends, it has reduced the amount of resources available to the private sector, which leaves precious few resources left for the production of tradable goods.

High GDP numbers do not necessarily translate into a "wealthy society." A "wealthy society" produces an abundance of consumer goods and services. The more "stuff" an economy produces, the better off everyone's lives become.