Worst of the Recession May Not Be Over

Economist Robert Higgs crunches some numbers regarding the current recession and suggests that the worst may not yet be behind us.

Real economic progress turns on a high rate of investment—primarily business purchases of structures, equipment, software, and additions to inventories—and on this front the news has been much bleaker and the prospects for quick recovery much less encouraging.

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.

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If real investment spending has taken a huge hit, however, federal government spending has raced ahead in high gear. Between 2007 and 2009, federal purchases of newly produced final goods and services—the federal government’s “contribution” to GDP—increased by more than 13 percent in constant dollars. Unfortunately, whereas private investment is the engine of economic growth, government spending (despite what generations of Keynesian economists have asserted) is the brake. Although increased government purchases by definition increase the measured national product, their substantive effect on the process of sustained economic growth is decidedly detrimental.

To understand this negative relationship, we need only to scrutinize how the federal government’s spending is determined, namely, by political processes devoid of economic rationality, and to examine the overwhelmingly adverse effect of government’s growth on the private economy’s functioning. In this light, we can appreciate that enhanced government spending does not actually bulk up the economy—it does not simply compensate for “leakages” from the circular flow of income generation, as the Keynesians imagine. Nor does it merely crowd out worthwhile private activity. Instead, it undercuts, penalizes, and distorts everything that private parties attempt to do to create genuine wealth. Beefed-up regulations, additional taxes, and government takeovers are the known killers of the economic growth process.

Much of the government’s “contribution” to GDP, of course, is pure waste, even if the recipients of the payments do nothing more to stand in the way of real progress: the government simply increases the compensation of its legions of drones and wreckers, or it spends money on items for which no private person, if he had any choice in the matter, would pay.

All of the Keynesian focus to boost consumer spending misses the mark because the economy’s most severe contraction in spending comes from private investment. Stimulus schemes will only consume much-needed capital from the economic system needed for the productive investment  required  for recovery.