Government Spending Is An Essential Component Of GDP

Trump administration officials have recently called for removing government expenditures from the nation’s measure of gross domestic product. GDP is famously the sum of national spending on consumption (C), investment (I), government purchases (G) and net exports (NX). So, the proposal would be to drop the “G” from U.S. GDP. Commerce Secretary Howard Lutnick and Elon Musk have expressed support in TV interviews and on social media for the idea. Yet, the underlying premise makes little sense. GDP is a crucial measure of economic efficiency—and excluding the government’s contribution would only serve to muddle the metric.

Why GDP Is Central To Understanding Economic Efficiency

GDP is the total market value of all final goods and services produced within a country in a year. It is a measure of economic efficiency, reflecting the value of production that takes place in markets. When the size and scope of market activity expands, we move closer to a system of complete markets—a condition typically associated with greater efficiency. Conversely, when market activity contracts, GDP falls, signifying a less efficient allocation of resources. Importantly, GDP accounts for “net production,” meaning it nets out intermediate inputs. So, if market activity only expands by adding new unnecessary intermediate stages to production, without adding any real final output, GDP accounts for this and will not be artificially inflated.

The ‘Remove Government From GDP’ Argument

Efforts to remove government expenditure from GDP are not new. Simon Kuznets, who is credited with inventing the modern concept of GDP, expressed reservations about lumping government spending into the measure. Later, Murray Rothbard, an influential libertarian economist, questioned in one of his books the inclusion of including government spending in GDP on the grounds that private production directly creates value by serving consumers, whereas government spending tends to be funded by coercive taxes and is therefore less connected to private demand and voluntary consumer choices.

However, even if one were to assume that all government expenditures are wasted, GDP would still be a useful measure of a nation’s income. One way to see government spending is as a luxury that wealthier societies can afford. If a country funds things like infrastructure, social services, or research subsidies, its income is not lower when those services create little value for the public. On the contrary, the nation is sufficiently well-off that its robust production can sustain those activities.

The reality is some government spending is wasteful and some is useful, and the same is true of private sector spending. Market prices used in calculating GDP capture, however imperfectly, what various institutions, organizations, and individuals are willing to pay for the market’s incremental outputs. Governments are one participant in markets for labor, goods, and services, and excluding their spending simply removes a substantial share of market transactions from the measure.

Mispricing Affects Both The Public And Private Sectors

Critics like Rothbard contend that publicly demanded goods are “mispriced” relative to their “true” social value, and therefore do not belong in GDP. The idea is that absent government spending, demand for these products would be much lower. But the very same critique applies to most privately demanded goods. In real-world markets, there is no guarantee that a consumer product’s price equals its value in its next best alternative use. Most prices are only vaguely connected to resource opportunity costs. Think of trivial consumer items like novelty toys or single-use plastic trinkets. It is entirely conceivable that in a perfectly efficient market, many products would never be made at all, much less find buyers.

GDP, however, is not in the business of making moral judgments. It takes market values as they are. Eliminating government’s component from the measure would do nothing to resolve the problem of private sector misallocation. Moreover, an increase in GDP presumably reflects an improved allocation of resources, since the allocation enabled greater overall output. Hence, GDP itself can be seen as an indicator of how effectively resource misallocations are being remedied.

The Bottom Line: Government Is Part Of The Market

GDP stands as one of the most meaningful indicators of social welfare available. To treat government expenditures as illegitimate is to deny that governments, just like businesses and consumers, are participants in real-world markets. If we decide to arbitrarily exclude some spending we personally don’t like—say, government services, or frivolous plastic knickknacks—then we soon aren’t left with much of a measure at all.

Far from being a relic or a measure in need of hasty correction, GDP remains an essential gauge of how much a society is able to produce and ultimately consume. In our complex, interconnected economy—where governments, consumers, and businesses all act in tandem—”G” belongs in GDP.