State and local government spending increased in the second quarter of 2010 for the first time in a year as municipalities splurged on capital improvements, but economists cautioned that the growth is unlikely to continue in the second half.
State and local government spending increased at a seasonally adjusted annual rate of 1.3% for the quarter ending June 30 and contributed 0.16 percentage point to real gross domestic product, the sector’s largest percentage contribution since 2007, the Commerce Department reported on Friday in its advance second-quarter real GDP report. Overall, real GDP increased 2.4% for the quarter.
The spending by governments came from gross investments, which include construction projects. Spending on consumption expenditures, which include government employee salaries, continued to decline.
One source of the governments’ spending boost lies in bond issuance earlier this year and last year. Those proceeds were put to work in the second quarter, economists said.
“A large part of that increase in state and local [spending] was due to borrowing and subsequent investments,” said Kevin Schultze, managing director at Stone & Youngberg LLC.
Governments started spending in the second quarter after a stretch of frugality amid the worst months of the recession, economists said.
Before the second quarter, the drop in state and local spending “was so deep” that governments “were not maintaining existing levels of capital stock,” said John Lonski, chief economist at Moody’s Capital Markets Group.
“A good deal of this [second-quarter] increase in capital spending perhaps merely consisted of replacement spending of worn-out, obsolete, rundown capital equipment, as opposed to an addition to the capital stock of state and local governments,” he said.
State and local government spending dropped 3.8% in the first quarter of 2010, the largest decline in 29 years, according to the Commerce Department’s Friday report.
Government spending was down 1.5% from a year ago in the second quarter and trails its eight-year average, from 2001 to 2009, by 2.8%.
The year-over-year decline in state and local spending will deepen in the second half of 2010 due to budgetary pressures, according to Lonski.
To ward off a potential slide in state and local spending, an Obama administration official on Friday called on Congress to provide additional federal aid to governments.
Speaking about the GDP numbers, Christina Romer, chair of the president’s Council of Economic Advisers, said it was essential that Congress pass “aid to state and local governments to prevent the layoffs of hundreds of thousands” of workers.
The GDP report also included spending figures for the American Recovery and Reinvestment Act of 2009.
The federal stimulus law pumped about $102.5 billion in current grants into state and local budgets. Federal spending provided governments with $92.1 billion in the first quarter.
And that spending may have staved off a more serious recession.
According to a report published last Wednesday by economists Mark Zandi and Alan S. Blinder, state and local government aid is an “especially potent form of stimulus,” the report said. “It is a defensive stimulus, forestalling draconian cuts in government services.”
So far, Congress has not acted to extend large portions of federal aid to state and local governments.
An extension to funds from the Federal Assistance Medicaid Percentages program died in the Senate in June over federal deficit-spending concerns.
Separately, a vote in the House to extend the Build America Bond program and other ARRA provisions has stalled until at least September.
