GDP, Welfare, and the Composition of Government Spending

by Will Wilkinson on March 1, 2010

David Henderson has an excellent essay on “GDP Fetishism” up at EconLib. Of the problem of valuing government spending, he writes:

Take the first inaccuracy—the valuing of government-provided goods and services at cost rather than at market prices. Many government programs actually destroy value rather than create it.

This highlights the fact that knowing how much the government spends (as a percentage of GDP, say) is to know something of questionable significance. Henderson talks about the waste created by the TSA. More generally, the United States spends a spectacular amount of money on war ships, fighter planes, and bombs. Most of this is simply unnecessary for the security or defense of the United States, and so amounts to little more than a combination of upward wealth redistribution and throwing money in a hole. That’s domestically. (I’ll pass over the problem of bringing the lost lives of bombed foreigners into the equation.)

Now, we dynamist market-liberal types are right that the government does many things, such as primary education, that competitive markets could do better and more efficiently. If all government spending on education became equivalent private spending overnight, GDP would stay the same (in the short term, before gains in education quality started to pay off in terms of higher productivity), though people would be better off. However, government spending on education, as inefficient as it may be, is giving people something they want and directly benefit from. Much (most?) military and security spending is not like that. My sense is that, despite the U.S.’s historically relatively modest level of government spending, the composition of U.S. spending is such that U.S. taxpayers get less of value in return for their tax dollars than do taxpayers in many places with higher taxes and higher levels of government spending. Which is to say that when using GDP per capita as a proxy for welfare, the U.S. comes off better than it should relative to, say, Canada or Sweden.

Now, one could argue that U.S. military spending and hegemonic U.S. military power, makes it possible for the Canadian government to spend on health-care, from which the Canadian people derive some benefit (even if the service is not provided as efficiently as it could be), rather than on aircraft carriers, from which the Canadian people would derive basically no benefit (since the Americans have already taken care of it). I think this is almost certainly true, but it’s just another way of making the same point: Canadians are better off and Americans are worse off than their GDP stats suggest.

If one additionally takes into account things like the U.S.’s unusually high level of spending on keeping its citizens in prison cells (which we could do much less of without getting more crime), it becomes even clearer that U.S. GDP figures overestimates the U.S. standard of living relative to other wealthy liberal democracies. The composition of spending matters.

The U.S. is an notable anomaly in the happiness data. Average self-reported life satisfaction rose with GDP per capita over the last several decades in almost all wealthy liberal democracies, but not so much in the U.S. The idea that the unusual composition of U.S. government spending gives Americans unusually poor value for their tax dollars might help explain this.

  • Ivan
    It' s not clear why do you portray a high level of government spending on health care in Canada as a good thing and a big advantage that we Canadians have? Do you really believe that government is better in delivering health care than private markets? Canadian health system is a joke.

    It's possible that America doesn't need that big defense budget. However, that certainly does not mean it needs more "social" of spending, i.e. spending on the entitlement programs (old and new ones).

    If you are really a "market liberal" you should understand that government spending for defense is a legitimate government function, while the spending for entitlement programs is not. On what basis do you consider the services provided by the government-run health care a better use of taxpayer dollar then services provided by the military? Or you are maybe not a "dynamist market-liberal" but simply - a socialist?
  • bbartlog
    Robert Kennedy made a similar point of GDP rather more eloquently (albeit from a leftish perspective) many years ago. The basic problem is that adding up a bunch of numbers that record flows of money does not, in fact, give you accurate information about human welfare. The fact that the ability to produce large amounts of goods is a necessary precondition to our happiness shouldn't cause us to therefore blindly adopt the idea that larger amounts of any sort of production must constitute a net good.
  • The US is 300+m people spread over a wide range of geographies with a wide range of religious, ethnic, etc identities. This is, of itself, an argument against high levels of federal spending since all that diversity greatly increases the chance of poor value spending due to communication gulfs.

    I have long found it ridiculous that people use Sweden, Norway etc as generalisable examples. Small, essentially monocultural societies can manage much higher return on government action since people are operating from much more common preference sets, assumptions about behaviour, there are high levels of communication and commonality between officials and citizens, etc. Run your eye over the list of high-scoring human development index countries and ask yourself how much cultural diversity they had when their policy regimes were being developed. On that basis, the US actually does comparatively well: in part, I would argue, because it does spend less as % of GDP. (Though the US actual level of government expenditure per person is usually quite comparable.)

    I am not sure, however, whether defense spending can bear quite the burden you are putting on it. At about 4% of GDP, US defense spending is high by developed world standards. That the return in happiness to Americans is comparatively low is entirely plausible. But I am not sure that the difference with Sweden at 1.5%, Norway at 1.9% or Australia at 2.4% is quite enough to get where you want to go. Though that it will get you some of the way is plausible.

    Incarceration rates seems a stronger case. But that is surely, in part, a diversity issue in itself. Crime (and particularly drugs) surely seem much scarier in a much more diverse country, even leaving aside whether diversity lowers trust so, of itself, encourages more crime.

    There seems a lot of interactive factors involved.
  • Sigivald
    The most useful thing about aircraft carriers from a non-military perspective is that they're a vastly mobile airstrip combined with a hospital, a vast store of supplies, and the ability to make something on the order of half a million gallons a day of fresh water.

    See Indonesia post-tsunami, Haiti just now.

    So while you can argue (though I disagree) that they're "useless" from a purely defensive point of view, I'd suggest that they nevertheless provide utility beyond "blowing up foreigners".

    (And I'd suggest that "lives lost" is the not sole question anyway - while I'm not unsympathetic to counting innocent deaths as a negative, I'm also sympathetic to counting "guilty" ones as a positive.

    In other words, while I'm absolutely willing to see "innocent people blown up by mistake or localized malice" as a negative, I'm also going to insist that "actual hostiles blown up" be counted as a positive.)

    Re. your argument in comments, there's a small problem with the logic there; nuclear arms can only deter an existential war or nuclear attack (and the latter only from a group worried about surviving an attack, or able to be nuclear counter-attacked; a terrorist group based in, say, London, isn't going to worry about the US nuking London to "hit them back", are they? Because there's no chance it would).

    But nuclear deterrence won't work when they know you have no credible threat of using it. The US can plausibly deter many wars of nation A against nation B (where neither nation is the US), because it can plausibly smack nation A down very, very hard - but it's difficult enough to do that with the military the US has now, let alone a radically smaller one.

    If all the US has is nukes, then practically speaking it has no leverage at all in such a conflict - because, again, nobody will believe for a second that the US will go all-in over, say, invading Kosovo or Kuwait.
  • Regarding the humanitarian benefits of aircraft carriers, you're conceding the point that Americans don't get the benefit of this spending. The point was how well GDP, a nation-level statistic, tracks national material welfare. If the benefit of much of the U.S.'s government spending goes to foreigners, that may be a good thing from certain moral perspectives, but it amounts to conceding that GDP overestimates US standard of living.

    Regarding nuclear weapons. How are they an insufficient deterrent to China, which is the example that Erick brought up?

    As always, there is a huge chicken/egg thing when talking about the military.
  • Erick
    As I said in my redacted post, nuclear weapons do not deter conventional warfare. The agreement by everyone of nukes won't be used unless nukes are used makes that so.

    Your chicken/egg thing was also addressed in that gross military spending by one party discourages a symmetrical war as the barrier to entry is too high.
  • Erick
    Having a dominate military prevents the wars from happening. Conflicts like Iraq and Afghanistan are a small price to pay to prevent a real war from happening. When the total casualties (killed and wounded) in six years is less then the deaths that have taken place in a single battle in previous wars I would say that it is a small price to pay.

    My biggest fear is that China becomes comparable to the US in military strength and decides that it no longer needs to be political. Asymmetric power balance keeps similar parties at peace.
  • Nimed
    My biggest fear is that China becomes comparable to the US in military strength and decides that it no longer needs to be political.


    People often bring up this point about China, and it's always a bit vague. What do you fear exactly? Is it China invading small neighbours? If so, our armed forces don't constitute an adequate deterrent now, because we simply won't risk a war with China over Bhutan. Is it China attacking the U.S.? That's evidently silly for a number of reasons: nukes, immediate huge losses from trade, even the substantial debt China holds over the U.S.
    It's only by keeping this sort of argument vague that anybody takes it seriously.

    Furthermore, let's not forget that China's military spending is partly determined by our own spending. An arms race mentality leaves everybody worse off, even in the best possible scenario where a conflict never erupts.
  • Erick
    http://www.reuters.com/article/idUSTRE6200P620100301

    These concerns aren't entirely speculative. China does pose a risk, ignoring it does not make it less so.
  • Joe
    I'm sure there are plenty of Chinese who would like to see China replace the US as the world's chief military busybody. But so what? There are people in the US who advocate all kinds of nonsense all the time. There's no guarantee any of it's going to become official policy, and even if it does, there's definitely no guarantee it's going to work (see the neocons and the middle east).

    But regardless of all that, the idea that China is a "threat" just reeks of typical US scaremongering. A threat to what? To whom? If we're talking about "world peace" here, I'd say the biggest threat at the moment is the United States and its futile and idiotic desire to control the entire world.
  • vilhelm_s
    But this article is equally vague. Suppose China does build up a military bigger than the US and Russia. Does that pose any threat to US taxpayers? Chinese taxpayers do not seem to be under a threat of US invasion right now, despite the US military being the bigger.
  • Erick
    Yes it does. If the goals expressed in the article are obtained, the US and Russian forces not being able to confront China in their home waters, then China can exert drastic forces on governments in their sphere of influence. Think of what is over there: Japan, Malaysia, Taiwan, etc. Most of the worlds semiconductors are manufactured in that part of the world. Not to mention China's own manufacturing. As we become more economically dependent on them, due to their export economy, and they become slowly more economically independent of us, due to their evolving consumption economy, we will have less bargaining power with them on that front to keep them in line. If they control all the cards, military and economic, what is to prevent or even discourage them from taking a position that is drastically exploitative of their trading parters?
  • Do you have any evidence whatsoever that reducing U.S. military spending by, say, 50% would increase the chance of war? Or is this an article of faith?

    The U.S.'s enormous nuclear arsenal is more than enough for deterrence.
  • Tigern
    It doesn't seem to be stopping the terrorists, which I think it's fair to say we are at war with them.

    Also, consider reducing that nuclear arsenal and showing less muscle in the Middle East and less support to Israel. SecDef Gates just stated last week that Iran could have a nuclear weapon in 3-5 yrs. That will drive Isreal to defend itself and who knows what Egypt or Hamas would do with Israel at war. So, yes, it does increase the chance of war not necessarily for the US but our allies too.
  • johndewey
    Our posession of nuclear weapons did not stop either Afghanistan or Libya from sponsoring terrorists.

    I agree that the U.S. spends too much on its military. But I disagree with your argument about the deterrence value of nuclear weapons.
  • johndewey
    I don't know, Will. I kind of think the enormous nuclear arsenal is useless as a deterrent because there is zero chance it will be used. That nuclear arsenal may prevent someone else from using their nuclear arsenal, but that's really about it.
  • Erick
    Not being a scholar on military theory I can't cite studies or anything of that nature.

    In your original post you cited Canada as not having a large defense budget because of the halo effect that the US provides. I would say that this extends to other NATO countries as well. European countries have virtually no defense budgets because they rely on the US to keep the peace. It is hard to be a belligerent when you have no budget for it.

    As for the 50% proposition I would turn you towards the concept of marginal cost. Say the military is rent on a house, most first world countries live in a thousand dollar/month house america lives in a three thousand dollar/month house. For a 'normal' country to live in the same neighborhood they would have to triple their housing expenses which would crush their budget in other fashions. If america would move into a house that was half as valuable all of a sudden they would only have to spend 50% more to compete. Not ideal, but doable even if only for a short time. By setting the bar high we ensure no one else even tries to compete, thus ensuring a modicum of peace. That would be my argument against cutting the budget significantly, modest cuts to our spending drastically reduces the price of entry for everyone else.

    The US nuclear arsenal is not a deterrent because we would never use it. The amount of flak we catch for using precision guided 500lbs munitions that go 50ft off course would be nothing compared to letting a 1kt nuke go off within 50 miles of a population center. Nuclear weapons deter nuclear war, not conventional war.
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