Tyler Cowen, in the interests of making the blogosphere waters ever muddier, has written a deeply misleading and confusing post about what exactly constitutes ‘austerity’:
Let’s say that private gdp is 100 and government spending is 100. Gdp then suddenly goes up to 200, so government spending as a percentage of gdp falls from 50% to 33.3%. This is not a contractionary event. It is fully possible to argue “government spending should go up too, to slot more public goods into the larger output,” but the initial change is expansionary, even though government spending as a percentage of gdp took a steep dive.
OK, here’s the problem: this is an absolutely ridiculous scenario that, for all intents and purposes, cannot happen. GDP and government spending/revenue are inextricably intertwined, so an increase in one will almost certainly affect the other. The only way this wouldn’t be true would be if the sector of the economy that grew were completely taxless, and so separate from the other sectors of the economy that it could barely be considered a part of the economy*.
If GDP grows, we expect government spending as a sector of GDP to grow by roughly the same amount**, in the absence of any changes to policy. This is because taxes are collected as a percentage of income, and as income grows governments must pay their staff more, too (I despair that I had to write that sentence). If the government were to pay its staff comparatively less this would be contractionary.
Let’s take the UK economy as an example. The government hasn’t really adopted any major new functions since the welfare state was established post-WW2:
Anyone familiar with UK economic history will recognise the various fluctuations, but overall, spending has hovered around 40% of GDP, even though the economy has obviously grown a lot over the same period. For government spending to decrease as a % of GDP, there would have had to be tax cuts and spending cuts (e.g. what happened around 1980).
There’s also the point that overall spending doesn’t tell us much about what’s going on in individual departments. As many on the left have been pointing out for quite some time, if you cut some areas too fast and during a downturn, you may create unemployment and so welfare spending will go up. This is what has happened in the UK. However, it doesn’t mean that large spending cuts aren’t taking place.
Government spending as a percentage of GDP doesn’t tell us everything, but it’s a good guide as to whether a country is cutting spending or not, even if you do need to factor in tax increases. In any case, it’s certainly better than real or nominal magnitudes with no context whatsoever.
*Insert snarky comment about the financial sector.
*Actually we’d expect it to increase due to Baumol’s Cost Disease, but I’ll put that to one side.