The State of the US Economy Is Worse Than It Looks

By: Gerard Jackson | Sun, Mar 7, 2010
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Many are looking to the expansion of factory production and the rise in GDP as evidence of economic recovery, proving once again how ignorant of economic history the great majority of pundits and journalists really are. How many times does one have to point out to these people that theory informs statistics, not the reverse, meaning that statistics need to be interpreted and for this one needs a theory? It is also an enormous help if one has a basic knowledge of economic history.

Once again, GDP is not a measure of growth but of spending: and even this has been distorted by the refusal of mainstream economists to include spending on intermediate good in the national accounts. Economic growth is in fact capital accumulation. It follows that a simple reduction in idle capacity adds no more to the capital structure than hiring thousands of temporary census workers. The Great Depression illustrates this point all too well.

Irrespective of what you have probably been taught the recovery was gathering steam well before Roosevelt could implement his statist New Deal policies, with the February-March period for 1933 clearly indicating a swift expansion (Roosevelt was inaugurated in March 1933) and the Federal Reserve Index of Production rising from 60 to 100 in July. Productivity was also rapidly increasing. (Frederick C. Mills, Prices in Recession and Recovery, National Bureau of Economic Research, Inc., 1936, p. 307.)

Mills was not alone in his assessment. It had been pointed out that in the "beginning in the third quarter of 1932 there was a positive recovery in business activity" and that this had been preceded by a downward adjustment in wages rates, hindered as it was Hoover's attempts to maintain money wage rates at pre-depression levels. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, pp. 231-2.)

Unfortunately, Roosevelt's policies swiftly put paid to any genuine recovery. His defenders point to the rise in GDP as evidence of his success. But, as I have pointed out, GDP is not growth. If they were right growth in GDP would have been accompanied by the net accumulation of capital. It was not. Professor Higgs calculated that from 1930 to 1940 net private investment was minus $3.1 billion. (Robert Higgs, Depression, War, and Cold War, The Independent Institute, 2006, p. 7).

W. Arthur Lewis calculated that from 1929 to 38 net capital formation plunged by minus 15.2 per cent (W. Arthur Lewis, Economic Survey 1919-1939, Unwin University Books, 1970, p. 205). Benjamin M. Anderson estimated that in 1939 there was more than 50 per cent slack in the economy. (Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States 1914-1946, LibertyPress, 1979, pp. 479-48). This is what some contemporaries had to say about Roosevelt's economic policies:

...the present Administration has shown but scant inclination to profit in any way from the errors of its predecessors. By consuming more than we have produced we have succeeded only in digging our way deeper into depression; we have tried to recover from depression by spending our way out of it rather than adopting the alternative procedure, -- the one which has effected recovery from every past depression, -- of saving our way out of it. By the policy of maintaining consumer purchasing power we have had to draw upon our store of past savings, and by so doing we have not only failed to keep up our accustomed rate of capital formation but have actually destroyed past accumulations by neglecting to provide for maintenance, depreciation, and obsolescence. (Ibid. pp. 165-166.)

I stated earlier that GDP greatly understates the amount of economic activity. Consumption as a proportion of GDP in the 1930s was higher than it is today, which contributed to prolonging the depression, with business spending taking up most of the remainder. However, accurate accounting at the time showed that "income produced or net product is roughly only about one-third of gross income." (Ibid. p. 72.) In other words, business spending was about 66 per cent of total spending. And it is the same today. We therefore arrive at the same conclusion as the authors: business spending "is the tail that wags the industrial dog", not consumer spending. (Ibid. p. 235.)

By taking into account total business spending we find that the "mild recession" that Bush 'inherited' involved a contraction of about 10 per cent. Investment is always hit hardest in a recession and this one is no exception. Fixed investment took a huge hit last year. (I do not consider residential housing to be a capital good and have therefore excluded it.) It is important to note this because an increase in fixed investment means an increase in net capital accumulation.

Strange as this might seem firms only invest and hire when there is a prospect of profit. This fact was apparently too complex for Hoover and Roosevelt to grasp. Obama apparently shares their innate inability to understand profit as a basic business motivation. To make it worse his spending, borrowing, tax, energy and regulatory proposals, etc., have created an atmosphere of uncertainty that is inimical to investment decisions. But what can we expect from a profoundly ignorant man with a thorough loathing of capitalism? As for his so-called economic advisors, they are a bloody disgrace to their profession. Loyalty to the Democratic Party means far more to them than intellectual integrity.

Note: In August 2008 I warned of the "dangerous irresponsibility of Democrats like Mr Obama whose ignorance of economics and economic history is easily on par with Pelosi's ignorance and stupidity. And that is truly frightening". Regrettably, many millions of Americans have yet to awaken to the danger.



Author: Gerard Jackson

Gerard Jackson

Gerard Jackson is Brookes economics editor.

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