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Government spending and economic growth, II [ClearOnMoney]
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Government spending and economic growth, II

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Commentary

Government spending and economic growth, II

14 Aug 2012 by Jim Fickett.

A pro-Keynesian article points to some weakness in Laffer's recent essay, but fails to show any positive correlation between government spending and growth.

Recently I reported on an analysis by Arthur Laffer suggesting that government stimulus may not have the desired effect of increasing economic output (Evidence that increased government spending does not help economic growth).

Most of the commentary that has followed Laffer's article is limited to rhetoric, but one article in the Atlantic I ran across does include some data. As with Laffer's article, this one is mainly political, and the quantitative analysis is not explained very well, but there are a few interesting points to note.

(1) The article, by Matthew O'Brien, does at least link to the IMF data, allowing the determined reader to follow up.

(2) O'Brien makes the valid complaint that one should look at spending itself rather than spending as a percentage of GDP since, using the latter measure, spending can appear to rise just because of the rapid fall in GDP after a crisis. But he then implies that falling GDP was the only reason Laffer saw a rise in spending in Estonia, one of the politically hot cases (“It is trivially true that when GDP goes down, government spending as a share of GDP will go up. That's how fractions work.”) But in fact, if you go look at the IMF data for Estonia, between 2007 and 2009 general government spending rose 18% in nominal terms and, normalized by the GDP deflator, rose 13% in real terms. Since both Laffer and O'Brien make much of the case of Estonia, and both distort the data somewhat, this suggests that anyone who really wants to understand this topic needs to look beyond the current political shouting match, and find some serious studies.

(3) O'Brien makes a number of other adjustments in the data used, and comes to a conclusion he likes: “The three countries that spent the least – Ireland, Greece, and Latvia – did the worst.” But the data choices are not very convincing (for example it seems odd to use aggregate government spending, but GDP per capita). And, most importantly, when O'Brien graphs the scatter plot using his data choices, the cloud of points is quite random. There is no evidence in his results that government spending improves economic output. Just for example, Latvia, Italy, Hungary, Switzerland and Germany all increased spending by similar, small amounts. Yet Latvia had a huge decrease in GDP while German and Switzerland had moderate increases in GDP.