What Are Government Purchases?
Government purchases are expenditures on goods and services by federal, state, and local governments. The combined total of this spending, excluding transfer payments and interest on debt, is a key factor in determining a nation's gross domestic product (GDP).
Transfer payments are expenditures that do not involve purchases. Social Security payments and farm subsidies are examples.
Understanding Government Purchases
One method of calculating a nation's GDP is to add up all spending in four major categories:
- Personal consumption
- Business investment spending
- Government purchases
- Net exports
The U.S. Bureau of Economic Analysis (BEA) has a number of sub-categories. For instance, it breaks down government purchases into federal, state, and local spending and also differentiates defense-related federal spending from all other spending.
- Government purchases include any spending by federal, state, and local agencies, with the exception of debt and transfer payments such as Social Security.
- Overall, government purchases are a key component of a nation's gross domestic product (GDP).
- In 2018, government purchases accounted for 18% of U.S. GDP.
The total for imported goods is subtracted from the final GDP total.
The Effect on GDP
Government purchases range from spending on infrastructure projects to paying civil service and public service employees to buying office software and equipment and maintaining public buildings. Transfer payments, which do not involve purchases, are not included in this category.
For example, the U.S. Bureau of Economic Analysis (BEA) estimated that GDP grew by 2.9% to $20.5 trillion in 2018. It noted that increases in personal consumption, business investment, net exports, and federal purchases offset decreases in state and local spending to arrive at that figure.
Government purchases contributed about $3.18 trillion, or about 17% of that total. About $1.23 of that was spending by the federal government, and 60% of its total spending was related to national defense.
According to the Keynesian theory of economics, government purchases are a tool to boost overall spending and correct a weak economy.
Where does all the money go? Most of it goes through the hands of consumers. Consumer spending accounted for about 69% of all GDP in 2018. Altogether they spent about $4.5 trillion on durable and non-durable goods and services.
Preliminary figures for the second quarter of 2019 found GDP growing at a 2.1% annual rate, notably due to increased personal and government spending.
Trends in Government Purchases
Government purchases have risen in real terms over recent decades:
As a share of overall nominal GDP, however, nominal government purchases have been falling:
The Keynesian View of Government Purchases
Government purchases are seen as a crucial element of a healthy economy in Keynesian economic theory.
That is, increasing or decreasing government spending is viewed as a key tool for regulating the business cycle. According to this theory, government spending boosts demand in two ways. First, the government directly boosts demand by purchasing goods, such as the steel needed to build a bridge. Secondly, it puts money in the pockets of both workers and suppliers, who then spend it on goods and services. This is known as the multiplier effect.