UNC History Professor Needs an Economics Lesson

A UNC-Chapel Hill history professor decided to weigh in on the economy in yesterday’s N&O. In so doing, he proves that he should stick to history because he displays an appalling level of economic ignorance.

Professor Peter A. Coclanis dogmatically recites the Keynesian mantra that more stimulus spending is needed to provide a “push” to consumer spending.

Consider the following facts. Consumer spending tanked in May. The official unemployment rate stands at 9.7 percent and 45 percent of the unemployed have been without a job for 27 weeks or longer.

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Ironically, the best thing we could do right now to secure the long-term viability of the American economy is to provide greater levels of governmental stimulus – thereby increasing the deficit – so as to strengthen domestic private demand, bring down unemployment and render sustainable our all-too-tepid recovery.

A few points need to made here. How can deficit spending increase “private demand”? Where does Prof. Coclanis think the government gets the money to finance its deficit spending? It can come in one of two ways: by the Federal Reserve creating more money, or the Treasury raising funds by selling debt instruments such as bonds or T-bills. Does Coclanis think that printing more green pieces of paper creates wealth and jobs? Of course it can’t, all that would do is erode the value of the money already in circulation and create a chaotic atmosphere for entrepreneurs attempting to calculate the soundness of potential business investments in light of an eroding purchasing power of the dollar.

Secondly, when the government sells its debt instruments, the money used to purchase them comes from previously earned wealth in the economic system. That leaves less investment capital for productive investment, restricting this necessary component of economic recovery. Thus, deficit spending does not magically increase “domestic private demand” it actually just shifts resources away from the private sector into the hands of the political class. In either case, it is clear that overall demand can not be increased by Coclanis’ recommendations.

Furthermore, the concern about consumer spending is misguided. A dip in consumer spending is not the cause of recessions, but rather the result of recessions. The true factor dragging our economy into recession (and keeping it there) is the sharp drop in investment spending. As I referenced back in March, research produced by economist Robert Higgs shows that slumping consumer spending does not drive recessions:

we find, for example, that as usual in an economic slump, private consumption spending has held up much better than private investment spending: the former fell by less than 2 percent, and most of the decline was erased during the third and fourth quarters of 2009, so that by the final quarter of last year, real private consumption spending was less than 1 percent below its previous quarterly peak.

Gross private domestic investment peaked in 2006. Between the first quarter of that year and the second quarter of 2009, it fell by almost 34 percent. During the following two quarters, it rose by only 10 percent, so that late last year it was still (when measured at an annual rate) running about 29 percent below its level early in 2006. Such a huge shortfall in investment spending portends an extended period of slow economic growth in the next few years, and perhaps in an even longer run. Worn-out equipment, obsolete software, ill-maintained structures, and depleted inventories are not the stuff of which rapid, sustained economic growth is made.

But isn’t consumer spending the key, because we are told that it makes up 70% of GDP? Last month, I exposed that myth with the research of economist Mark Skouson

Granted, personal consumption expenditures represent 70 percent of gross domestic product, but journalists should know from Econ 101 that GDP only measures the value of final output. It deliberately leaves out a big chunk of the economy — intermediate production or goods-in-process at the commodity, manufacturing, and wholesale stages — to avoid double counting. I calculated total spending (sales or receipts) in the economy at all stages to be more than double GDP (using gross business receipts compiled annually by the IRS). By this measure — which I have dubbed gross domestic expenditures, or GDE — consumption represents only about 30 percent of the economy, while business investment (including intermediate output) represents over 50 percent.

Thus the truth is just the opposite: Consumer spending is the effect, not the cause, of a productive healthy economy.

Prof. Coclanis’ economic prescriptions would only prolong the recession in the short run, and his desired massive debt accumulation would be a drag on the economy for generations to come.

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