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GDP report: Austerity is stifling the recovery

COMMENTARY According to the advance report on GDP released Friday morning, economic growth for the fourth quarter of 2011 was 2.8 percent, a rate of growth near the average rate of GDP growth in recent decades of roughly 2.5 percent. Average economic growth is enough to keep us from losing ground, but re-absorbing the millions of unemployed workers into productive employment will require an acceleration in GDP growth. We need a growth spurt that exceeds trend by some margin, something we haven't seen yet, and without that we are headed for a very slow recovery.

Unfortunately, when the components of GDP -- consumption, investment, net exports, and government spending -- are examined, it's not clear where that spurt will come from. Households lack the income needed to support a burst in consumption, and they are in no position to support a large rise in debt-fueled consumption. We wouldn't want that in any case.

Investment has two components -- business investment and the construction of new houses.  Businesses are waiting for the outlook to improve before increasing investment (Business investment will follow GDP growth, not lead, and the housing market is unlikely to give us the necessary spark.) Net exports are a possibility. They were featured in President Obama's State of the Union speech as part of the path to a better economy, but problems in Europe make an export boom unlikely anytime soon. Besides, not every country can be a net exporter. Other countries will not sit idle while we try to increase our share of exports to world markets, so that even if the world economy grows robustly gaining, market share will not be easy

GDP growth in Q4: Good, not great

That leaves government spending. However, these numbers are moving in the wrong direction, and that is unlikely to change given the emphasis on reducing the long-run budget problem. In fact, premature austerity -- cutting spending before the economy is ready for it -- is taking a toll on the recovery. The fall in government spending reduced fourth-quarter growth by 0.93 percent; if government spending had remained constant, GDP growth would have been 3.7 percent, rather than 2.8 percent.

This is the opposite of what the government should be doing to support the recovery. We need a temporary increase in government spending to increase demand and employment through, for example, building infrastructure. That would help to get us out of the deep hole we are in. Instead, the government seems to be trying to make it harder to escape.

We do need to address our long-run budget problems once the economy is healthy enough to withstand the tax increases and program cuts that will be required. But the idea of "expansionary" austerity has failed. Austerity in the short-term simply makes it harder for the economy to recover and delays the day when you can finally address budget issues without harming the economy. The lesson is that government needs to support the recovery, not oppose it through a false promise that contraction of one sector in the economy will be expansionary. And given how far we still have to go before the economy is healthy again, it's not too late to put that lesson into practice.

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