How Government Expenditure Affects Economic Growth - Case Study Example

Effect of government expenditure on the economic growth of USA. Introduction All along, economists have debated about the effects of federal government expenditure on economic growth. They argue that government provides important goods and services such as health, education and infrastructure. Some economists argue that an increase in government spending in the provision of goods and services creates an incentive for increasing the level of production. Those who do not agree with this view argues that the federal government should transfer the right of provision of these services to the private sector. They claim that the private sector is well known for efficiency and effectiveness in production and therefore this goods and services would be produced and delivered more efficiently, leading to a more robust economy. This paper will explore the question: what are the effects of federal government expenditure on the economic growth? It will focus on exploring how government expenditure affects economic growth. This research will endeavor to look at the statistics on the federal government spending pattern and economic growth during different times, in order to test the above named thesis. Though government expenditure results into both positive and negative economic implications on the USA economic growth, negative effects are more conspicuous. The paper will focus on both positive and negative effects of government expenditure in the United States of America economic growth. The paper will be seeking to answer the question “What would be the effects of government expenditure on the economic growth of USA?” The above research topic and question will facilitate a clear understanding of the paper at a glance. Previously, there have been various attempts to explain the effects of government expenditure in real terms on the economic growth. Such researches will be brought on board to identify their strengths and weaknesses and also help in this analysis. Considering that the USA is a superpower, with an impressive growth rate of GDP, it would be interesting to know how the government expenditure has affected this level of economic growth. Literature review According to the World Bank, the term government expenditure refers to the total value of all goods and services purchased by the government for both consumption and investment purposes. The federal government expenditure is comprised of government final consumption expenditure and gross fixed capital formation but excludes transfer payments. Final consumption expenditure refers to the goods and services acquired to satisfy direct needs of the citizens. Gross fixed capital formation refers to goods and services for purposes of infrastructure investment or research spending. On the other hand transfer payment refers to money transferred by the federal government such as social security payments. USA is among the top countries with the highest levels of government spending. There are several researches that have been done addressing the same subject, but they have produced contradictory findings as to the effects of government spending on economic growth. Grier and Tullock (1989), carried out a research on 115 countries and showed a negative relationship between growth rate and government spending. Kormendi and Meguire ( 1985) found an insignificant relationship between government expenditure and economic growth rate, Landau (1983), having done an analysis of 96 countries found a negative relationship between government expenditure and economic growth and Ram(1986) used a theoretical model to analyze summer and Heston (1984) data from 114 countries and came up with a positive relation between economic growth and government expenditure. According to the public choice report (2007), one percent increase in government spending would reduce the rate of economic growth by 0.36 per cent. Other research previously done such as public finance review (2008), indicate that high federal government spending leads to a lower economic growth rate. The quarterly journal of economics (2007), found a negative relationship between total government expenditure and economic growth rate while American government accountability office (2008) found that infrastructure spending failed to increase the number of new jobs hence reduced the rate of economic growth. In the year 2007, the federal government increased total federal spending by 11 per cent to stand at $3 trillion, enacted an emergency spending and tax rebates worth $333 billion and $105 billion respectively. However, all this policy measures failed to increase the economic growth. The same lawmakers went ahead to double the above spending policies by proposing a $3 billion economic stimulus bill. Unfortunately, this high spending did not increase the rate of economic growth. Government spending on giving rebates In the year 2001, the federal government borrowed billions of dollars from the capital market and transferred them to consumers in the form of rebates. By the end of the first quarter of that financial year, the consumer spending rate had grown by 5.6 per cent and the private domestic investment had dropped by 22.7 per cent. This led to 1.6 per cent economic growth in that quarter which remained the same for the next two years. Government spending in general compared to European nations In the 1930s, 1960s, and 1970s the American government undertook massive spending with the sole aim of increasing economic growth but on the contrary this failed to increase the economic growth. On the other hand in the 1980s and 1990s, the American government reduced its total spending by one fifth of its total gross domestic product. As a result they realized the highest growth rate ever. Comparing other economies government spending and the resulting economic growth, the American government spends less than all the European Union nations and yet it enjoys faster economic growth rates. Outsourcing funds to finance federal Government spending. The American government increased spending, merely redistributes existing income without having any significant improvement in productivity and therefore nothing to create additional income. Every dollar injected into the American economy emanates from somewhere. If this money spent is borrowed from the domestic investors, those investors will be left with less money to invest in the private section of the economy. Alternatively the federal government can borrow from foreign countries. This means that the balance of payment will adjust, reducing the net exports by the same margin, leaving the gross domestic product unchanged. Government spending on consumers Increase in federal spending weakens the private sector by directing resources toward less productive uses and increasing competition in the market thus impending economic growth. The federal government spending changes the composition of total demand by increasing consumption and reducing investment. Economic growth comes as a result of increased production of goods and services. Production process requires an increase in labor productivity and supply. If the federal government spending policy on labor supply and productivity are favorable then production will increase leading to a higher economic growth. Government spending on future productivity Federal government spending on productivity improvement may aid future economic growth. Investments in education, training, infrastructure, and research and development can increase long-term productivity rates which translate to increase economic growth. For instance, construction of the modern railway system will take a long time and does not improve economic growth in the short run but a well functioning railway system can. Federal government spending and the crowding out effect Increased federal government expenditure can lead crowding out effect on the private sector. Crowding out effect kills the private sectors which significantly contribute to economic growth. Compared to the private sector, the federal government is known to be inefficient in production and distribution of goods and services. This translates to major losses specifically in parastatals which consequently slows the rate of economic growth. Federal government expenditure on infrastructure Federal government expenditure on infrastructure has no effect on economic growth. To finance these projects the government acquires necessary funds either from tax or borrowing from other sectors of the economy. This leads to a reduction in the production of this sector with a roughly equal margin as the one which will be realized in economic growth once the infrastructure element is complete. In the year 2008, the federal government through the Emergency jobs Appropriation Act of 1983, invested billions of dollars in the construction of a highway in the hopes of reducing the escalating unemployment rate. Unfortunately, the audit done by a government agency revealed that the project failed meets its objective. Federal government spending on bailing out states Federal government to state bailout spending policy does not lead to economic growth. Any state’s budgetary funding does not by any means stimulate production. For the federal state to fund any state government, it can either get the funds from taxes or borrow from investors. This leads only to a redistribution of money which as discussed earlier, does not positively affect economic growth. Since 2000, the federal government has sent approximately $467 billion to states and local government to offset their budgetary deficits. This has never translated into economic growth according to statistics. When the federal government bails out financially irresponsible states, it only encourages more irresponsibility. For instance, in 2003 states bailout, after the 2002 – 2003 economic recession, states embarked on a spending spree instead of increasing their rainy day fund. Infrastructure, health and education services are provided by the government at a subsidized rate, below the market rate in a competitive market. The above reasons don’t mean that all the effects are positive. The cost benefit analysis done in this paper shows that the negative effects outweigh the positive effect. Conclusion Does the government expenditure have any effects on the economic growth of the USA? According to the above analysis the answer is yes but the negative effects outweighs the positive effects. The major driving force of economic growth is capital investment, technological advancement, increased labor productivity and fully motivated entrepreneurs. The above improvement in the factors of production leads to increased production, which translates into economic growth. Government spending creates a favorable environment for private sector investment in the named factors of production which leads to increased economic growth. Work cited Lutes, John. Balance of payment and economic growth: New York: Herper and Brothers, 1959. Print Richard, Wagner. Fiscal Sociology and the Theory of Public Finance: Cheltenham: Edward Elgar Publishing, Ltd., 2007. Print Read More