Obama's Economic Policy is a Recipe for Lower Living Standards

By: Gerard Jackson | Tue, May 5, 2009
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Any economic recovery under Obama will be short-lived. His supporters assert that his utterly reckless spending proposals are necessary for a sustained recovery. As evidence they state that statistics prove that consumer spending has led every US economic recovery, at least since WW II. But this merely demonstrates that statistics generally prove nothing in themselves. Statistics need to be interpreted, which means that one needs a theory. It follows that applying the wrong theory will very likely render a wrong answer, particularly if the statistics are incomplete.

Those economists arguing for a consumption-led recovery genuinely believe that consumer spending accounts for about two-third of total economic activity. They are gravely mistaken. Their error is to omit spending on intermediary goods, those goods that pass through the capital structure, which in turn consists of incredibly complex stages of production. This omission is defended on the curious grounds of double counting. To be blunt, it's ridiculous account for fixed investments, i.e., durable goods, while ignoring 'non-durable' capital goods merely because they are unfinished.

What these economists do not realise is that these particular goods are also savings. If spending on these goods were to contract then living standards would fall. Therefore, only when we take into account intermediary spending does a true picture of actual gross spending emerge. Once this is done consumption as a proportion of total spending drops to 30-odd per cent. This completely changes the perspective on economic recovery.

By taking into account total spending we will find that recoveries were not led by consumption at all. In fact, I would bet that spending by manufacturing was the leading indicator. But as I have pointed out, national accounting methods omit this vital factor. (This approach suggests that the 6.1 per cent contraction in first quarter understates the drop in economic activity which may in fact be about 12 per cent or more).

Let us assume, as our baffled commentators do, that consumption will increase economic activity. Now what would this really mean for the US economy? Producers, in case anyone hasn't noticed, direct production and investment in response to changes in demand. It ought to be clear that if consumption is to lead recovery the effect will be to direct resources from the higher stages of production to the lower stages, those closest to the point of consumption.

The term for this is capital consumption. In English so plain that even a post-Keynesian can understand it, stimulating the economy by continually promoting consumer spending will, at the very best, retard economic growth or, at worst, even shorten the capital structure and hence eventually lower living standards. The hope of the more intelligent economic observers is that current rates will stimulate manufacturing first leading to increased investment. (This thinking is usually based on the fallacious accelerator concept). However, there are several serious obstacles to this rather Pollyanna view:

1. There is the problem of serious 'excess capacity', which really means malinvestments that have yet to be liquidated.

2. The effect of artificially lowering rates before all of the boom-created "imbalances" have been eliminated will, if the stimulus is successful, only pile more malinvestments on top of the surviving ones which will then have to be liquidated at a later date.

3. If the malinvestments/imbalances are particularly severe rate cuts might prove ineffectual in the short-term.

4. As I have pointed out more than once, artificially cutting rates is what brought about the boom-bust situation in the first place. Greed had absolutely nothing to do with it.

The US economy also has the misfortune of facing two enormous and politically created problems: Bernanke and Obama. Bernanke is doing what he can to flood the economy with money. This can only lead to surging inflation, rising interest rates, current account problems and depreciation. Obama's spending, taxing, energy restrictions and other regulatory policies amount to an assault on capital accumulation. Unless he abandons these destructive policies any inflationary recovery engineered by Bernanke will be short-lived and possibly followed by a distinct fall in living standards.



Author: Gerard Jackson

Gerard Jackson

Gerard Jackson is Brookes economics editor.

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