Note: This article was originally written on October 1, 2000. The theme of the article, that more social spending by the Federal government creates higher economic growth (and vice versa) is actually the thing that got me backing away from the stock market in the summer of 2000. This article predicted a slowdown in economic growth based on the slowdown in social spending (as a % of the total Federal budget). Sure enough, growth in real GDP from 1997-2000 was 3.2% per year. From 2000 through 2002 growth slowed to 2.1% per year.
Whatever Goes Around, Comes Around
By Richard Torgerson
"Whatever goes around, comes around" has been a truism for years, a folksy restatement of the Golden Rule or the Law of Karma. Perhaps all of us have seen this truism at work in our own lives as we decided to give up something we valued, be it time, energy or money, only to have it come back to us in abundance afterwards. As we start to immerse ourselves in the fiery political rhetoric of the season, I thought it wise to reflect whether this truism has validity on the national economic scene. I believe it does.
One of the great debates over the last few decades has been the role of social spending and Social Security in our society. It's not my intention to analyze all of the sociological aspects of the issue, not only because I don't have the time, but I'm also not qualified to do so. Beyond those aspects though, a whole host of economic rationales have been concocted over time to favor or oppose lending more support to those in need. Those opposed to social spending have frequently argued that such spending is a drain on the economy, since higher social spending require higher taxes to pay for that spending. Looking at the actual track record of the economy and our governmental spending suggests the opposite however.
To compare the effect that social spending has on the economy, we examine the total percent of Gross Domestic Product represented by Federal government transfer payments to individuals. p;These payments to individuals include Social Security, Medicare and Means-Tested Entitlement programs (collectively termed 'welfare'.) The higher percentage of the total economic pie, the higher degree of effect those payments should have on the economy. To test the notion that bigger proportions of social spending means a bigger drag on the economy, we charted the annual growth of GDP overlaid on top of the chart of social spending (I'll post the graph soon for readers here.) The visual suggestion is clear. With a time lag of up to two years, economic growth strengthened after social transfer payments increased as a percentage of GDP, at least for the last twenty years or so.
From 1978 through 1980, social expenditures decreased as a percent of GDP primarily due to inflationary pressures driving GDP up faster than the Federal expenditures could keep pace. Gross Domestic Product growth also peaked in 1978, with growth plummeting down to -1.17% in 1983, closely following the decline in social spending. Partly due to that negative GDP growth and partly due to rapidly rising Social Security payments, the level of Federal transfer payments to individuals rose from 10.2% of GDP in 1981 to 11.5% of GDP in 1984. This rise was also followed by economic recovery, with GDP growth reaching a robust 7.73% by 1985.
Partly due to restrictive welfare policies of the Reagan administration and also due to Social Security 'reform' in that era, Federal transfer payments to individuals fell over the rest of the 80's, reaching a low of 9.9% of GDP in 1990. Economic growth patterns showed the same direction, with GDP growth falling from 7.73% in 1985 down to -0.38% in 1992. With the economic climate changing towards more support for social expenditures and also reflected by the election of a Democratic President in 1992, transfer payments to individuals rose from 1992 lows up to 11.9% in 1996. That period coincides with the modern period of economic expansion, with GDP growth advancing to a high of 4.49% in 1998. Most recently, Federal payments to individuals have been leveling off and trending down somewhat, representing 11.3% of GDP in 1999. At this point in the discussion it's no surprise that GDP growth slowed slightly as well to an annual rate of about 4.2% curr! ently.
The correlation is very strong. It does appear that as social spending on individuals rises as a piece of the economic pie, so does subsequent economic growth. How could this be? To answer this, we need to look at an old economic concept not getting much attention lately called the 'velocity of money'. This concept tries to measure the number of times a dollar changes hands in a given period of time. Each time a dollar changes hands represents an economic transaction. When I buy a hot dog from 7-11, my dollar changed hands from me to the 7-11 cash register. What I received was a hot dog, plus the value added labor of producing that hot dog and presenting it to me. Thus, each economic transaction is an opportunity for someone's labor to be converted into money, which adds a quantifiable piece of economic growth. That dollar in the 7-11 cash register will soon leap out and be presented to the employee as part of his paycheck.! Another transaction. The 7-11 employee might spend that dollar on his electric bill. Another transaction. The more times that dollar changes hands in a given time period means that dollar contributed more to economic growth.
Now as it turns out, different Federal expenditures have different 'velocities' from this standpoint. The most extreme example of a low velocity investment is the huge amount of money spent on nuclear missiles. Once constructed, these missiles get buried in the ground, with very little interaction with the economy from that point forward. The type of Federal expenditure with the highest velocity turns out to be the direct payment of cash to a poor person. Those funds, rather than being buried in an underground silo, are put back into circulation extremely fast, buying food or shelter virtually immediately. Food purchases especially have high velocity as grocery stores immediately put 99% of cash receipts right back to keeping the food shelves fully stocked and paying a large store-level payroll. Also, a very high percentage of food and shelter expenditures stay in this country longer, with very little going overseas to subtract from our own domest! ic growth.
So here is a concrete example of the virtues of tithing and of the Golden Rule. If we as a society are willing to part with a larger portion of our tax dollar pie for those in need, we are very quickly rewarded with greater economic growth enlarging the pie itself. Now none of this suggests that if we taxed people 100% and paid out 100% of that to Social Security and welfare that we would enjoy unprecedented growth. But at the same time, the hard data does show that if we have a larger pool of people with adequate income and adequate resources, it makes for larger opportunities and larger growth for the whole economy.
This has two implications for us right now. First, we can infer that if social expenditures keep sliding as a percent of GDP, then a slowing of economic growth may be more likely moving forward. That has a whole host of ramifications for our stock and bond investments over the next few years. Second, this practical manifestation of "whatever goes around, comes around" may be very instructive as we compare and contrast the claims, biases and orientations of the different folks that want to be elected President. Their stands on social spending and Social Security should be carefully scrutinized. "
Oct 1, 2000 Richard Torgerson © 2003