We are all amply familiar with the neo-Keynesian wisdom, repeated endlessly on both sides of the aisle, that government can reliably stimulate private sector prosperity through ever-larger outlays. As Congress debates a $2.4 trillion reconciliation package, we should consider whether debt-fueled government spending ever delivers renewed growth. The notion is not just wrong; it is dangerously counterproductive.
Our latest research white paper,Stimulus Does not Stimulate, shows that governments that spend more deliver slower economic growth than governments that spend less, in every single five-year span in the last 60 years. Economies with government spending between 15% and 30% of GDP have historically enjoyed annual real per capita GDP growth rates of 2% to 6%, the sweet spot for prosperity. But beyond around 30% of GDP, additional spending erodes growth. Of course, some government spending is necessary, and some is desirable. Essential investments in infrastructure, defense, law enforcement, and courts are necessary for a well-functioning society. And a humane society will provide a safety net for the needy. But, above 30% of GDP, less is more.
Why does more government spending lead to slower growth? When government expands, it diverts human and financial capital from the private sector, where efficiency and innovation are rewarded, to the public sector, where incentives are often misaligned. The “Magnificent Seven” are based in the U.S., not Europe or Japan, because the U.S. has historically kept government spending relatively low, allowing the private sector to do what it does best. As public outlays rise, the private sector necessarily contracts – along with its innovation and growth.
Across the developed world, the fashion in the corridors of power is to argue that we can spend our way to prosperity by borrowing more. This was a seductive idea when interest rates were low. But, as interest rates rose – along with inflation, as a result of the spending – we are left with interest payments that now exceed defense spending for the first time in U.S. history. This is not sustainable. The capital markets are brutal disciplinarians: Apollo Global Management has noted recently that U.S. credit default swaps now trade at levels similar to Italy and Greece, an ominous sign.
This discussion has immediate relevance for the current reconciliation debates.
At a time when Republicans need to demonstrate that they can govern even with whisker-thin margins in both houses of Congress, Congress again shows its skill at turning reconciliation into a pork-laden reaffirmation of the status quo.Between Rand Pauls admirable desire to see deep cuts and Murkowskis well-intentioned desire to avoid cuts to Medicaid and SNAP eligibility and to clean energy credits, the party is on the cusp of snatching defeat from the jaws of victory.Everyone has their own red lines, but the perfect cannot be the enemy of the good. Even red lines may need to be bent for the common good.
Reconciliation will likely require multiple bills. Success can be achieved if every player in the party, in the House and Senate, is content to vote for a compromise that does not take big steps in the wrong direction. Stealth constraints on spending, like the REINS Act or allowing the executive to sequester spending that is provably funding fraud, can be useful, even if difficult to score in advance.
If we are serious about growing our way out of debt, the only long-term path is to cut spending. This does not mean slashing essential services or abandoning the vulnerable. It means prioritizing efficiency, eliminating waste, rooting out fraud, and ensuring that every dollar spent delivers real value. It means resisting the temptation to use reconciliation bills as a vehicle for new spending.
Policymakers face a clear choice. We can continue down the path of ever-larger government and ever-higher debt, or we can embrace fiscal discipline and unleash the private sector to drive real, sustainable growth. The path we choose will shape our future. The public seems ready for some measure of spending discipline, more than it has in many years. This is the moment to set a more sustainable course.
Rob Arnott is founding chairman of Research Affiliates, a $160 billion asset management firm based in Newport Beach, CA.
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Alex Pickard is senior vice president of Research Affiliates, a $160 billion asset management firm based in Newport Beach, CA.
