Government: Size Matters

The Bureau of Economic Analysis has published private-consumption numbers by state for 2019. There is quite a bit of spread between the states, a spread that shows how different fiscal policies visibly shape the economy. States where private industries gain ground vs. government have seen a stronger trend in household consumption than states where government has grown.

First, let us take a look at the growth numbers for household consumption. Figure 1 reports annual averages for 2015-2019:

Figure 1: Household consumption growth, current prices

Source of raw data: Bureau of Economic Analysis

Spending by households accounts for two thirds of our economy, on average. It is the driving force behind economic growth; no capital formation takes place in an economy where consumers do not spend money. Therefore, the variations between states are significant for how the economies of those states fare generally.

Next, the growth in consumer spending is compared with changes in the private sector of the economy. Figure 2 reports a comparison between two annual averages:

a) The private sector of the economy as a share of total GDP; when the share declines, government grows; and

b) Household consumption growth; when the growth rate falls, it suggests that consumer finances are tighter.

These two averages are then compared for two time periods: 2005-2009 vs. 2015-2019. States where the private sector is bigger in the second period get an index number above 100; states with a smaller private sector score below 100. Likewise, when the average growth rate in consumer spending is lower (higher) in the latter period than the former, a state scores an index below (above) 100.

As Figure 2 explains, the message is clear: in states where the private sector shrunk over time, household spending also tapers off.

Figure 2: Trends in GDP, comparing 2005-2009 to 2015-2019

Source of raw data: Bureau of Economic Analysis

There is one interesting piece of information from Figure 2 that is independent of the balance between the private sector and government. Consumer spending growth has tapered off everywhere; the national average has fallen from 5.7 percent per year in current prices in 2005-2009 to 3.9 percent per year in 2015-2019.

Breaking down this growth trend by state, Figure 2 tells us loud and clear that wherever government expands relative the private sector, consumer spending also takes a beating. The decline in consumption growth is simply bigger in states where government has expanded.

Wyoming is the most extreme example. In 2005-2009 consumer spending grew at 8.5 percent per year; in 2015-2019 that rate was down to 2.2 percent (again in current prices). That is the largest drop of any state. During the same period of time the private-sector share of the economy declined more than in any other state: the index number for Wyoming is 95.76, worse than in any other state, even Alaska (albeit by a razor-thin margin).

It is hardly surprising that states with a growing government have weaker consumer-spending trends. Government depresses the economy in two ways. First, it socializes sectors of the economy, including segments of the labor market, depriving it of market competition. This weakens growth by stagnating economic activity; under competition, doing more with less means more economic resources from one year to the next. Government eliminates that process in sectors it takes over. As a result, the bigger government gets the more slowly the economy grows.

Secondly, government needs to pay for itself. The bigger it gets, the higher its taxes, fees and other charges. Even where taxes don’t go up, fees and charges tend to rise, making government chip away at household finances and weaken the economic strength of businesses. Less money remains in the private sector, where growth slows down and consumers have smaller margins to spend from.

In short: it pays to keep government limited.