The GDP Shock

What? Economic growth as measured by the GDP actually fell in the fourth quarter by 0.1%?

Hardly anyone anticipated this. USA Today and other purportedly reliable venues immediately assured the world that this does not mean recession. Somehow after hanging onto to GDP numbers for three years — recovery is here despite your internal sense that the economy is still in a ditch — now we are told that the the GDP figures are really just misleading. Recovery is still here, says the mainstream press.

And why? It all comes down to military spending. It apparently fell by 22.2% in the fourth quarter, the largest drop in more than four decades. It is conventional that it would drop in the fourth quarter but not by much. Hilariously, many commentators are assuring us that if we subtract the falling stuff and keep only the rising stuff, we would see that the GDP is actually rising.

That’s one way to look at it! Such is the absurdity of discussions about GDP and economic growth today. No one knows which way is up and which way is down.

Also, if a fall in military spending can crash the GDP that much, to what extent is the GDP growth over the last three years due to government spending?

Just consider the baseline assumption here that because government spent less, economic growth is naturally slower. Actually, in world where reality matters, it would be the opposite. The less the government spent, the fewer resources it would extract from the private sector and therefore the more available for investment and higher the likely growth. It is the same even if government floated bonds rather than taxed; the less debt that is accumulated, the less we seeing of the crowding-out effect. Cuts in government spending should always be good news for economic growth — just as less crime is generally good news for the private sector.

In this way, the USA Today line that we should not panic contains a kernel of truth. The fall in military spending is actually good, whether this is reflected in the GDP or not. The whole problem of national income accounting is fundamentally flawed. GDP should not rise as government spent more. Government’s take from the private sector should be subtracted from productivity. This theme is explored in great depth in Mark Skousen’s edited book of Hayek essays Hayek’s Triangles. Skousen’s discussion of this topic in his introduction is rooted in some theoretical critiques of Keynesian-style GDP calculation that were advanced in the pages of Murray Rothbard’s Man, Economy, and State.