YOU DECIDE: Is government getting larger or smaller?

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

By Dr. Mike Walden
North Carolina Cooperative Extension

A recent headline in a major national newspaper caught my eye. The headline read, “Government Getting Smaller in the U.S.” Could this have been a misprint or a joke, although this national paper is not known for its practical jokes? With the record levels of spending, especially at the federal level, and sky-high government deficits and debts, how could anyone make the case that government has been shrinking?

Well, believe it or not, an argument can be made that the government sector has recently been contracting. To understand how, I need to give some background on what exactly is meant by government spending.

A long time ago, economists found it useful to think of what government does in two broad categories. The first category is government production. Government production means the government sector is actually generating a product or service that citizens use. The military, police and court system, all of which provide protection; roads, which allow the movement of products and people; and the educational system, which makes learning and skill acquisition possible; are all good examples.

The second category is government transfers. Here government acts as a middleman for shuffling money from one person to another. Who gets to spend the money changes, but the government has no hand in making anything. Social Security, Medicare, Medicaid and the various social-support programs like TANF (Temporary Aid to Dependent Families), Food Stamps and the EITC (Earned Income Tax Credit) are examples of government transfer programs.

So with government production, a tangible product results — an aircraft carrier or tank, a trained soldier, a road or bridge or a high school graduate. Government also “owns” the final product (tank, road) or facility (K-12 school) producing the outcome. But with government transfers, the government only determines who pays and who spends. Individuals still make the specific spending decisions and own the purchased products or service.

With this distinction in hand, we can better understand the headline. When the writer stated, “Government Getting Smaller in the U.S.,” he was referring to the first category of government, government production. And he was correct. Usually, government spending on production rises over time, as when the road system expands and school capacity grows to accommodate a larger population.

However, for the first time in 17 years, this wasn’t the case last year (2011). After taking out inflation, government production fell more than 2 percent. The drop was consistent across-the-board for federal as well as for state and local government production and for military and non-military production alike.

In contrast, government transfer spending continued to rise in 2011. Indeed, over the last decade, government transfer spending has increased almost twice as fast (after inflation) as spending for government production.

So what does all this mean? I think there are three important implications, for the economy both short- and long-run and for how people view government.

First, the reduction in government production spending gives support to those concerned about government belt-tightening (austerity measures) contributing to the apparent slowing of economic growth. Some economists argue the significant government production cutbacks in Great Britain have already led to a British double-dip recession. These economists worry the same could happen in the U.S. Of course — and this should not be a surprise — not all economists agree with this assessment.

An assessment that economists almost universally agree with is that total government spending is being driven by government transfers. For example, a decade ago government production spending was almost 50 percent larger than government transfer spending. Today, spending levels are virtually equal, and projections show future government transfer spending far outstripping government production spending.

The conclusion is obvious. If we are to move toward a balanced government budget, particularly a balanced federal government budget, by moderating spending, much of this moderation will have to occur in transfer spending.

Last, I think the dichotomy between spending on government production and spending on government transfers has a big impact on how people view government. Most everyone is aware of government production spending because we all drive the roads, most families use the public schools and we see (especially here in North Carolina) or hear about our military. Yet transfer spending mainly benefits those directly receiving the transfers.

So as government grows and more of this growth goes to transfers and less goes to production, this trend may contribute to more people concluding they are paying more for government but receiving less.

Is government getting larger or smaller? The answer may depend on how you define and combine government spending, but as always, you decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The College of Agriculture and Life Sciences communications unit provides his You Decide column every two weeks. Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective/