Austerity Is Already Here, and It's Killing the Recovery

State and local government spending has already declined over the past 18 months, dampening growth and hiring

As Congress bickers over how to cut the deficit, some economists warn that cuts too deep too soon would endanger the recovery. Unfortunately, spending has already declined on the state and local government levels. As a result, we're seeing weaker results in the two economic indicators that matter the most: hiring and economic growth. Without the headwind created by the state and local governments, the recovery would look significantly stronger.

First, let's be clear what we're talking about here. The objection is not that state and local governments should have done more to stimulate the economy than they had in, say, 2009. The criticism is that if they hadn't done less, then the economic recovery would be on firmer footing.

A Recovery With 326,000 More Jobs

In March 2010, the U.S. economy finally began to add jobs again. Every month since then, private sector employment has grown. Yet almost every month since then, state and local governments have cut jobs. Without those layoffs, the U.S. labor market would have 326,000 more people employed through May 2011. Here's a chart showing job growth with and without the impact of state and local government cuts:

You can see that the jobs picture looks better if you exclude the effect of state and local government layoffs. The only real outlier was October 2010, when state and local governments added 31,000 jobs. If no government jobs had been shed since March 2010, the unemployment rate in May would have been 8.8% instead of 9.1%. That might not seem like a huge change, but surely there would be some positive benefit to consumer sentiment if the headline rate was below 9% at this time, instead of having ticked back above it over the past few months. Moreover, those 326,000 more people who would still have jobs would have spent more money to stimulate the economy.

A Recovery with $8.8 Billion More GDP

The negative impact of state and local government austerity isn't limited to employment: it has also affected GDP over the past year, and especially over the past two quarters. Since the fourth quarter of 2009, state and local spending has dropped by $8.8 billion. If state and local government spending had remained constant over these five quarters, here's how GDP growth would have looked compared to actual experience:

How much better would we feel about the U.S. economy having grown by 3.4% and 2.4% over the past two quarters instead of 3.1% and 1.9%? This change would have both tangible and intangible positive effects on the economy. Not only would there have been more money spent to stimulate the economy, but sentiment would be a little higher, as growth would be looking a little bit better.

A Taste of What's to Come?

Remember, all of these benefits to the economy would have come merely if state and local governments didn't cut jobs or spending -- not if they had hired or had increased spending compared to 2009 levels. To be sure, budget troubles are forcing state and local austerity, but if the federal government were able to stop their bleeding, then the recovery would be proceeding with greater strength. The additional money and jobs in the economy would help to stimulate a higher rate of growth going forward as well, which means we'll miss the impact of this lost economic activity in quarters to come as well.

There's a strange sort of silver lining here, however. This analysis shows that the private sector is actually doing relatively better than the overall numbers we've been seeing suggests. If things would look better absent state and local governments, then the picture of just the private sector plus the federal government must look better than what we've been seeing. Unfortunately, this revelation will do little to make consumers more confident: all they read are reports of weak hiring and weak economic growth, since the impact of state and local government is included.

If this analysis isn't bad enough news for the recovery, the federal government might be gearing up to also begin cutting back. The U.S. has a long-term deficit problem, but the short-term consequences to a fragile economy outweigh the benefits of cutting the deficit in the short-term. If Washington needs proof of that, it only needs to look at how state and local government austerity has already stunted the recovery.

Image Credit: REUTERS/Max Whittaker