12 Sep
2011
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Can Government Spending Boost GDP?

It’s an age-old question that is often not given a complete answer.  But with the introduction of Obama’s new “American Jobs Act” (which at the time of this entry is not yet written) last week, the question deserves another take.  While the news media and pundits cite specific example on why or how it may or may not work, the more fundamental response is critical to properly framing the debate.

In what way can spending be said to “boost GDP?”  What does it mean to “spend?”  What does it mean for GDP to “grow?”  And when GDP grows, what is implied about this spending?  These are important questions that bear consideration.

GDP is a measure total receipts in a year – the total amount goods and services sold – and thus, by definition, also a measure of income (vis-a-vis the principles of standard accounting).  More transactions at a higher average price than the year before means a growth in GDP.  Positive GDP numbers indicate short term growth economic growth.*

A healthy, growing economy needs good (i.e. profitable) investment.  It needs to carefully direct its capital, which is scarcer than was anticipated.  For the government to succeed in actually boosting GDP numbers, the government will have to out-compete the professional investors who keep the private sector moving.  A Congress of 535 individuals who totally lack on-the-ground knowledge of business conditions must make more profitable decisions than the owners of these companies.

Barack Obama, if this bill passes, will have to quickly become the best teacher, contractor, energy innovator, etc. if it is to succeed in doing what he says it will do.  Why is this necessarily so?  Because Obama, in spending additional resources, is actually diverting those resources from private hands who almost certainly know better than he and Congress do – across all industries.

For more information, see Hayek’s The Use of Knowledge in Society.

*Positive rises of GDP over the long term can indicate inflation of the money supply.

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