Why Government Spending Does Not Stimulate Economic Growth

In a throwback to the 1930s and 1970s, Demo­cratic lawmakers are betting that America’s economic ills can be cured by an extraordinary expansion of government. This tired approach has already failed repeatedly in the past year, in which Congress and the President:

• Increased total federal spending by 11 percent to nearly $3 trillion
• Enacted $333 billion in “emergency” spending
• Enacted $105 billion in tax rebates
• Pushed the budget deficit to $455 billion in the name of “stimulus.”

Every one of these policies failed to increase eco­nomic growth. Now, in addition to passing a $700 bil­lion financial sector rescue package, lawmakers have decided to double down on these failed spending pol­icies by proposing a $300 billion economic stimulus bill. Even though the last $455 billion in Keynesian deficit spending failed to help the economy, lawmak­ers seem to have convinced themselves that the next $300 billion will succeed.

This is not the first time government expansions have failed to produce economic growth. Massive spending hikes in the 1930s, 1960s, and 1970s all failed to increase economic growth rates. Yet in the 1980s and 1990s—when the federal government shrank by one-fifth as a percentage of gross domestic product (GDP)—the U.S. economy enjoyed its great­est expansion to date.

Cross-national comparisons yield the same result. The U.S. government spends significantly less than the 15 pre-2004 European Union nations, and yet enjoys 40 percent larger per capita GDP, 50 percent faster economic growth rates, and a sub­stantially lower unemployment rate.

When conventional economic wisdom repeat­edly fails, it becomes necessary to revisit that con­ventional wisdom. Government spending fails to stimulate economic growth because every dollar Congress “injects” into the economy must first be taxed or borrowed out of the economy. Thus, gov­ernment spending “stimulus” merely redistributes existing income, doing nothing to increase produc­tivity or employment, and therefore nothing to cre­ate additional income. Even worse, many federal expenditures weaken the private sector by directing resources toward less productive uses and thus impede income growth.

Spending-stimulus advocates claim that govern­ment can “inject” new money into the economy, increasing demand and therefore production. This raises the obvious question: Where does the gov­ernment acquire the money it pumps into the econ­omy? Congress does not have a vault of money waiting to be distributed: Therefore, every dollar Congress “injects” into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistrib­uted from one group of people to another.

Spending-stimulus advocates typically respond that redistributing money from “savers” to “spend­ers” will lead to additional spending. That assumes that savers store their savings in their mattresses or elsewhere outside the economy. In reality, nearly all Americans either invest their savings by purchasing financial assets such as stocks and bonds (which finances business investment), or by purchasing non-financial assets such as real estate and collecti­bles, or they deposit it in banks (which quickly lend it to others to spend). The money is used regardless of whether people spend or save.

Government cannot create new purchasing power out of thin air. If Congress funds new spend­ing with taxes, it is simply redistributing existing income. If Congress instead borrows the money from domestic investors, those investors will have that much less to invest or to spend in the private economy. If Congress borrows the money from foreigners, the balance of payments will adjust by equally reducing net exports, leaving GDP unchanged. Every dollar Congress spends must first come from somewhere else.