Government Spending and GDP: a $5.4 Trillion Benefit Who Some Think is a Pending Disaster

Understanding how GDP is calculated lends greater insight into an analysis on America’s economic struggles during the last decade. Tyler Cowen's new book The Great Stagnation reviews how government spending has impacted GDP. In Cowen’s analysis for the 10 years ending in Q4 2010, real GDP – adjusted for inflation -- grew 18.07%. Real GDP less government expenditures grew 8.46%.

By 2011, federal, state and local government combined contributed $5.4 trillion in government consumption, government investment and government transfer payments — the equivalent of 36% of our GDP. If you were not aware of this fact, you might wish to join us in Part IV of our series on Gross Domestic Product. Using the Expenditure Method for calculating GDP = C + I + G + Net Exports

Our base year of analysis during this series has been 2011. If we look at 2011, we see that nominal GDP was $15,094 trillion. Of this, the major component was personal consumption: $10,726 trillion. Yet, as we have examined previously, how the components and factors used in calculating GDP are defined is critical in understanding what is. And they are not included in this key economic measure.

Government spending (or government expenditure) includes all government consumption and investment but excludes transfer payments.

Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classified as government final consumption expenditure.

Government acquisition of goods and services intended to create future benefits, such as infrastructure investment or research spending, is classified as government investment (gross fixed capital formation), which usually is the largest part of the government gross capital formation.

Government final consumption expenditure and government gross capital formation, together constitute one of the major components of gross domestic product.

Government expenditures that are not acquisition of goods and services, and instead just represent transfers of money, such as social security payments, are called transfer payments. While total government spending in 2011 equaled $5.4 trillion per the definitions of GDP computation subtracting out transfer payments develops a value of $3 trillion.

It should be noted, Federal aid to state and local governments is netted out to avoid double counting. For additional information the Bureau of Economic Analysis, the division of the Commerce Department that collects the NIPA data, calculates the contribution of each component of GDP to its real (inflation-adjusted) growth rate is an excellent reference.

It is critical in our understanding of what constitutes GDP to realize government transfers make up nearly 20% of all expenditures defined as personal consumption. The $2 trillion that governments allocate to personal consumption from transfers such as pensions, social security, Medicare, Medicaid and other related programs has and will continue to have a major impact on the ability of America to continue its current spending.

Since 2000, both in federal transfer payments to state and local governments and in direct spending, total government expenditures have greatly increased. In 2000, total government expenditures at all levels including transfers and excluding investment was $3.5 trillion. As we noted at the beginning of this essay, by 2011 that level of spending had increased to $5.4 trillion— unadjusted for inflation.

The subsections of America’s increased government spending 2000 – 2010 are well known such as; $478 billion Medicare/Medicaid, $417 billion in defense, and $312 billion in Social Security.

In reviewing the facts concerning how much and where does our Government spending impact GNP, a case can be made that Cowen’s assessment is plausible, Government spending has been propping up our economy for much of the past decade.

I hope you have found our exploration of what constitutes government spending in reference to Gross Domestic Product enlightening. Please consider joining us for Part V of our series as we next investigate the Net Exports, arguably the most misunderstood factor of Gross Domestic Product. The first three essays in this series can be found in the Business Section of PolicyMic.

GDP and the U.S. Economy, 3 Ways to Measure Economic Growth

US GDP is 70 Percent Personal Consumption

US GDP: How Three Types of Investment Impact Economic Growth.