The Shrinking Government Sector

Tim Taylor highlights a recent publication from the Cleveland Fed on "The Shrinking Government Sector" showing, among other things, that "government spending on goods and services was actually higher in the much of the 1970s than it is today":

Government Demand and Income Transfers, by Tim Taylor: Every intro econ class points out that the total aggregate demand economy is the sum of consumption plus investment plus government plus exports minus imports. It also points out that the "government" category for "government demand" in this equation isn't the total government budget, but rather government spending on purchasing goods and services and paying employees. Parts of the government budget that involve a transfer of funds to consumers are not treated as part of demand by government , but instead are treated as demand by consumers. Daniel Carroll gives the facts behind this distinction in "The Shrinking Government Sector," published in the April 2012 issue of Economic Trends from the Cleveland Fed. ...

Several intriguing patterns emerge from these graphs:

1) I hadn't known that government spending on goods and services was actually higher in the much of the 1970s than it is today, nor that government demand for goods and services had such a big decline in the 1990s. For those who have a vision of government doing things like building roads, providing education and national defense, enforcing laws, and paying for research and development, government is doing less of those things as a share of the economy now than it was a few decades ago.

2) The recent rise in government transfer payments is extraordinarily large 4%: nearly 4% of GDP during the recent recession... For comparison, total defense spending in 2011 was 4.7% of GDP. Thus, just rise in government transfer payments has been roughly comparable to total defense spending. ...

Increases in transfer payments during recessions stabilizes spending. Without such a large infusion of transfers from the government, the recession would have been much worse (though I would have preferred more actual spending in the mix, and more spending overall). It's also likely that transfer payments will fall back to to a level near the 12 percent level that existed prior to the recession (in fact, as the graph shows, the turnaround has already started), that is, the recent run-up is temporary. This is not what we should be worried about.

What ought to concern us is the fall in government spending in such areas as "building roads, providing education,... paying for research and development," and so on. At a time when we ought to be using infrastructure spending to help the recovery along and to enhance future growth prospects -- the price of this spending is at rock bottom levels we are unlikely to see again anytime soon -- we are cutting spending sharply (note the fall-off in spending at the end of the first graph, and the more general downward trend). Using the temproary run-up in the deficit from the recession to block needed spending on infrastructure is a penny-wise, pound-foolish approach to governing. Even without including the substantial help it provides to the recovery, the benefits of infrastructure spending outweigh the costs. We are worse off, not better off, when such spending is blocked by deficit hawks.