The Illusion of Growth
By Sheldon Richman Tuesday, October 30, 2012
The U.S. government announced last week that gross domestic product grew in the third quarter at an annualized rate of about 2 percent. That’s hardly vigorous growth, but considering the previous quarter’s annualized rate of 1.3 percent, the news was received with optimism.
But optimism is unwarranted. As the U.S. Commerce Department’s Bureau of Economic Analysis explained: “The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), federal government spending, and residential fixed investment.”
To put it another way, what grew was not the real economy but GDP -- a statistical construct that is subject to myriad assumptions and dubious measurements of, for example, inflation. And the reason GDP grew at a higher rate is that the government and consumers spent more than previously.
So despite what pundits, politicians, and the news media tell us, this doesn’t bode well for the future because economic (as opposed to GDP) growth requires investment, which is made possible by saving. But saving is consumption deferred. (One reason people save is to consume more in the future than they can consume today.) An economy cannot consume its way to real, sustainable growth.
Commentators never tire of saying that consumption accounts for more than 70 percent of the economy. But this is highly misleading. Adam Smith accurately wrote, “Consumption is the sole end and purpose of all production.” It does not follow, however, that the way to make an economy grow is to consume more. That sabotages the potential for real growth.
The fallacy was made popular by Lord Keynes, who thought recessions and depressions were signs of inadequate aggregate demand and that therefore saving was harmful. But it’s not true. Rather a recession is the inevitable consequence of a previous boom, or bubble, prompted by money inflation and cheap-credit policies pursued by the government’s central bank. These policies stimulate interest-rate-sensitive sectors of the economy (such as housing and stages of production remote from the consumer goods level) that depend on real savings for sustenance. But when the Federal Reserve System creates money out of thin air in order to lower interest rates, it gives the illusion of new savings (deferred consumption) and therefore misleading signals to entrepreneurs, who direct resources and labor to parts of the economy that never would have expanded without the inflation. The recession occurs when the central bank switches gears, true consumer preferences come to light, and the inflation-induced investment is revealed for what it is: malinvestment.
Economic recovery requires a shift in resources and labor from where they were mistakenly diverted to where people’s real consumption/saving preferences direct them. This process is costly and time-consumingand that’s where the need for saving come in. If the recovery is to proceed, government and its central bank must keep hands off, and interest rates have to be allowed to find their true market levels. If growth is to resume and employment increase, market corrections can’t be impeded. But politicians and central bankers aren’t typically willing to step aside in such circumstances because they want to be seen to be doing somethingeven if the something is the wrong thing to do. That’s the position we’re in today.
The numbers illustrate the point. As economist Robert Higgs of the Independent Institute noted last year, Bureau of Economic Analysis data show that “real personal consumption expenditure recovered from its recession decline by the fourth quarter of 2010. Continuing to grow, it now stands (as of the most recent data, for the second quarter of 2011) even farther above its pre-recession peak.” Consumption spending has continued to rise since Higgs’s article was posted.
In other words, if anemic demand keeps an economy in the doldrums, the U.S. economy should be booming. Yet growth is sluggish, unemployment is still near 8 percent, and the labor force participation rate is abysmally lowthe lowest since 1981.
So what’s wrong with the economy? As Higgs wrote a year ago:
- The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase but because the true driver of economic growthprivate investmentremains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its prerecession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the “capital-consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.
Companies are sitting on billions in cash, but they are not investing enough to produce a vigorous recovery. Why not? A big part of the reason is what Higgs calls “regime uncertainty”:
- Private investors, despite the full recovery of real consumer spending and the increase of real government spending for final goods and services, remain apprehensive about the future of new investments, especially new long-term investments. I have argued repeatedly during the past three years that an important reason for this apprehension and the consequent reluctance to make new capital commitments is regime uncertaintyin this case, a widespread, serious fear that the government's major policies in areas such as taxation, Obamacare, financial reform, environmental regulation, and other areas will have the effect of depriving investors of control over their capital or diminishing their ability to appropriate the income that the capital generates.
What’s horrifying is that President Obama, Fed Chairman Ben Bernanke, and Congress have been doing precisely the opposite of what economic recovery requires. In addition to the programs Higgs enumerates, the Obama administration has tried to prevent the housing market from correcting for the massive distortions wrought by the Fed and federal housing programs as they inflated the infamous bubble. The government and its central bank seem determined to reinflate the housing bubble. For example, under QE3 the Fed for the foreseeable future will buy $40 billion worth of mortgage bonds each month, providing easy money and low interest rates for the mortgage market. “Our mortgage-backed securities purchases ought to drive down mortgage rates and put downward pressure on mortgage rates and create more demand for homes and more refinancing,” Bernanke said.
This is precisely the sort of policy that set the table for the housing bubble and consequent Great Recession in the first place. No good comes from artificial stimulation of markets.
The Fed also plans to continue to hold the federal funds rate to near zero well into 2015. To the extent this keeps other rates down, people will be discouraged from saving and encouraged to spend and borrow. Thus, as noted at the outset, the very thing needed for sustainable economic growthsavingis being discouraged by the government.
“Policy makers have cost the U.S. economy a decade or more of normal economic growth,” Higgs writes. That represents real hardship for millions of people. The politicians and their appointees once again have shown themselves to be incompetent managers of the economywhich is to say of our lives. It is time that all privileges, regulations, and interventionist entitiesincluding the Fedwere eliminated and that a free economy be allowed to emerge. Economic growth is too important to leave to the government.
http://www.theprojecttorestoreamerica.com/ --
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