The Economic Growth Illusion

Over at National Review's The Corner, Reason Foundation's Samuel Staley writes: 

The problem with the way we count economic growth is that it focuses on spending, not investment, efficiency, entrepreneurship, or technological innovation. Anything that boosts spending is automatically assumed to produce growth. Spending, no matter what the source, is the lever government pulls to produce jobs and income.

This is the growth illusion embedded in economic forecasts and in the way we calculate gross domestic product, and we are seeing its negative effects in the anemic numbers posted by the general economy. Increases in nondefense spending are almost exclusively redistributions of revenue from one group (working individuals, or future generations through debt) to current non-earners or non–wealth producers. Even the business spending may be illusory, particularly if the increases in inventory built by domestic manufacturers were based on distortions from gimmicks — cash-for-clunkers, housing tax credits, or stimulus infrastructure projects that literally involved digging holes and then filling them back in again. That's hardly a recipe for growth, but the GDP estimates and economic models forecasting future growth don't take this into account; they report these expenditures as spending and therefore economic growth.

Full thing here.

Comments

[Take Care of THIS!]

Anything that boosts spending is automatically assumed to produce growth.

Keynes sure left a great legacy, didn’t he?

[Hazel Meade]

Indeed. If the dollar amount spent is the only important factor, then increasing the price of everything should make people wealthier. Produce exactly the same amount of goods and services, just pay more for them. On credit. Instant prosperity, right?

[Alan Vanneman]

Funny that Mr. Staley didn’t come up with this analysis when George Bush was president. This wouldn’t be result-oriented, would it?

[John Thacker]

You mean Mr. Staley who wrote this when George Bush was president, to take one example:

Of course, I gave up the notion that Republicans stand for free markets long ago (see steel, lumber and fish tariffs and farm subsidies under Bush for a few of the more recent reasons)….
That means two of the three drivers of today’s higher gas prices ?the ethanol mix and geopolitical uncertainty?are policy-driven. Guess who’s in charge of federal policy? Republicans.

There are plenty of other examples, but the comment system dislikes having too many links.

But making accusations of hypocrisy is easier than actually arguing or thinking, right Vanneman?

[David E. Gallaher]

You should change your name from Thacker to Whacker. Excellent whack on Vanneman.

[JR]

Very nicely executed B slap

[John Thacker]

I am reminded of how you, Vanneman, on your blog merely noted that it was “interesting to see” whether those who opposed race-based preferences would also oppose legacy preferences, when it’s well known that California, and then Georgia eliminated legacy admissions when race-based preferences were eliminated. You substitute the allegation of hypocrisy (and racism) for any substantive argument.

Such (along with accusations of unspoken racism) are always the arguments that Vanneman turns to when he can’t make a good one.

[The Gobbler]

Shouldn’t you be at home working on your next Alexandre Dumas novel?

[David E. Gallaher]

Hey, Sam! Good catch!

[Jason]

On NPR this morning, the host and guest were talking about how US GDP growth was slowed by imports and that if we excluded imports, GDP growth would have been double.

And I’m sitting there thinking, aren’t rising imports a sign of a recovering economy? Aren’t they things people and companies want or need?

[Smoot?Hawley]

YOU LIE!

[JW]

By that logic, shouldn’t we be banning all imports then? I’m sure we can get by with the domestic output of petroleum.

[Metazoan]

I better start growing that oil-algae in the backyard then.

[Paul Krugman]

The problem with the way we count economic growth is that it focuses on spending, not investment, efficiency, entrepreneurship, or technological innovation. Anything that boosts spending is automatically assumed to produce growth.

Yeah, and?

[stuartl]

Most government spending affects the economy the way eating food with a high glycemic index affects your blood sugar. It works for a little while, but then crashes because it did not spur on any kind of long lasting economic activity. Reducing taxes is more like food with a low glycemic index. It doesn’t give you an immediate high, but carries you forward in the longer term by spurring on the creation of useful businesses and services. It gives people more money to buy what they want.

[adamsmith1776]

I think Sam hit the nail on the head. I remember in Macro-Econ 101, that GDP=C (consumption) +I (Investiment) +G (Government waste–although I think they called it just Government spending). With that formula, you can always boost GDP by spending more on G. The G has to come from someplace though, and it seemed to escape everyone’s attention that it came from Investment, but true growth can only come from returns on Investment. BTW–these are the same folks who taught us that natural unemployment was around 7%. Then came Reagan, with lower taxes, and deregulation, and somehow the natural unemployment rate dropped to something like 4-5%. Just think what it would be without a minimum wage to price black kids out of the market and unemployment insurance to subsidize people sitting on the sidelines (but I digress)

[Hazel Meade]

Magic formula … spend more on G, to give to people to increase C. Multiplier effect!!!!

[T]

Sure. There’s also a huge chunk of broken window fallacy in using spending as a proxy for growth. If my house burns down, I get to spend money on a new one. W00T! Housing market uptick! Yeah, not so much.

Of course, this is the curse of all data gathering. It’s often very difficult to get the data you really want, so you use proxy measures to get you close. After long enough, everybody forgets you’re trying to approximate a different value instead of the one you’re measuring. The measurement becomes the variable, not a proxy for the real variable. Econ has particularly huge problems in this area. The canonical example in my field is bolt torque vs. preload.

[Ken Shultz]

“The problem with the way we count economic growth is that it focuses on spending, not investment, efficiency, entrepreneurship, or technological innovation.”

I think it’s necessary to keep growth separated from the things that make it happen, but those things right there are what makes growth happen, and it’s kind of a national disgrace that so few people have any clue to what makes economies grow.

The only thing I’ve even heard of the Obama Administration maybe supporting that would help make the economy grow is a trade agreement with South Korea.

…but that makes so much sense (on the efficiency variable up there) that it’s hard to imagine the Obama Administration getting on board.

[Old Mexican]

The problem with the way we count economic growth is that it focuses on spending, not investment, efficiency, entrepreneurship, or technological innovation.

GDP indeed focus on consumer (and government) spending as a way to measure economic growth. From its simplistic (i.e. really stupid) formula, authoritarian assholes (sometimes called with a very dark sense of humor “government policy makers”) conclude that if the government increases spending, then voila, instant growth! Just like a watered Chia pet!

However, GDP has another very serious problem which macroeconomists never seem to explain – it does NOT take into account capital spending, supposedly to avoid double accounting (as if economics had anything to do with accounting!).

This is an extremely serious conceptual flaw, since if you want to look at spending as a way to measure economic activity, then capital spending SHOULD BE the metric that deserves the attention, since what companies, factories and enterprises spend for their daily operations tells you how much PRODUCTIVE ACTIVITY they are performing.

Consumer spending can also be extremely misleading if one takes into account how much of it is actually credit-driven, and not INCOME driven.

[Old Mexican]

Even the business spending may be illusory, particularly if the increases in inventory built by domestic manufacturers were based on distortions from gimmicks[…]

I don’t think the gimmicks account for much of all capital spending of these last 2 Quarters, as they were sector-specific. But that does not mean the gimmicks should be ignored, no – only saying that I don’t think they had that big of an effect on businesses overall. It would still be MORE ACCURATE to look at business (capital) spending instead of consumer and government profligacy.

[Metazoan]

I read recently a piece that had been posted on the Marginal Revolution called “Economists have no clothes,” which, aside from the title’s frightening nature if taken literally, takes economists to task for approaching the economy in a failed way for over half a century (ie, approaching it as an engineering problem).

[Old Mexican]

Re: Metazoan,

Not so the Austrian economists.