This article first appeared in the St. Louis Beacon, March 12, 2013 - The sequestration of federal government expenditures is in place. Just how will the mandatory cuts in federal government spending impact the economy? To answer that, consider several pertinent facts.
The sequestration will reduce federal government expenditures by a total of $85 billion, which is split between defense and other government agencies (some programs, like Medicare, remain untouchable). The cuts are not immediate and will take time to be implemented. This phase-in lessens any immediate effects on the economy.
Eighty-five billion is a big number, so let’s add perspective. The total value of goods and services produced in the U.S. economy (Gross Domestic Product) is over $15 trillion. The $85 billion reduction in the planned increase in government spending thus amounts to less than one-half of 1 percent of total output. The sequestration also represents a small reduction in total government spending. Even after the reduction, federal outlays remain nearly 25 percent of GDP, a level greater than its pre-recession level and its historical average.
The sequestration thus makes a small dent in the massive run-up in government spending that has taken place. Even before the recession, growth in government spending outpaced that of the economy. The massive buildup in spending related to the recession only accentuated the trend.
The potential economic costs are likely to be small. The well-respected independent St. Louis forecasting firm of Macroeconomic Advisers predicts that the sequestration could boost the unemployment rate a maximum of only 0.25 percentage points by year-end 2013. It also projects a small, short-term effect on economic growth. In a recent forecast, Macroeconomic Advisers estimates that the sequestration will lower output growth from its original forecast of 2.6 percent to about 2 percent for 2013. More telling is the fact that it projects a post-sequester 2014 growth rate that is actually 0.1 percentage higher than its original forecast of 3.3 percent.
The costs associated with the sequestration could be reduced. Stanford University economist John Taylor argues on his blog that any negative economic impact could be reduced considerably simply by giving government agencies the flexibility to allocate the cuts within their budgets. If agency heads had discretion over where the cuts could be made, potential job loss and slower economic growth would be greatly reduced. If the bottom line is to reduce government spending, is punishing current government employees the sensible approach? Though headline grabbing, is canceling White House tours really the path to fiscal stability?
Reducing the size of government should be done. Many believe the government is becoming too large a player in the economy. The federal government’s total expenditures — spending on goods and services and social programs —are likely to increase as a proportion of goods and services in the overall economy. In 2000 the ratio of total federal government expenditures to GDP was about 19 percent. Today that ratio stands at almost 25 percent.
While this number partly reflects actions taken during the recession, it also is an omen of a dangerous trend. Between 2002 and 2008, the economy grew at a sluggish rate while government expenditures were rising faster. And projections by the Congressional Budget Office suggest that without sequestration the ratio of government spending to GDP will remain above historical levels for the foreseeable future. This only underscores the future difficulties we are likely to encounter with intractable deficits and debt as the entitlement crisis becomes reality.
A sensibly implemented cut in government expenditures represents a first step in a long-term strategy aimed at reducing budget deficits and lowering government debt. While the sequestration is a clumsy tool to achieve fiscal stability, it represents an opportunity to make government more cost-effective and to reduce the expansion of government.
Rik Hafer is a distinguished research professor in the Department of Economics and Finance at Southern Illinois University Edwardsville and a scholar at the Show-Me Institute.