The Growth Illusion

by Samuel R. Staley

Reading the reports on the strikingly anemic growth of the U.S. economy during the second quarter (just 2.4 percent), I thought of Khrushchev’s 1956 admonition, “We will bury you.” In the 1950s, economists in both the Eastern Bloc and the West believed that policymakers could pull some levers and push some buttons in the economy and — presto! — produce economic growth. Of course, policymakers couldn’t and didn’t, and it was the dynamic, innovative, entrepreneurial economies that buried the planned ones.

Alas, it seems we’ve backtracked to those same naïve models, which ignore the importance of entrepreneurship, economic discovery, and risk-taking as drivers of real economic growth. When the press reports on our nation’s slow economic growth, they usually claim in the same breath that the economy has been bolstered by government spending. Take the following quote from the Washington Post’s coverage:

Another big rise in growth [in the second quarter] came from the federal government, which rose at a 9.2 percent annual rate, including a 13 percent pace of gain in nondefense spending. That reflects in part the fiscal stimulus action that was enacted last year, but which will taper off beginning in the second half of the year.

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.

When Khrushchev made his infamous claim, his belief in his country’s superior economic prowess was based on similar assumptions about spending and consumption. Khrushchev said that “history is on our [Marxism’s] side”; today, we know that history was not. Fortunately, we are not a centrally planned economy, and Obama’s policies won’t necessarily lead us there. But when will our economic policymakers recognize the failure of these old models and assumptions? Otherwise, it will be “Lost decade, here we come!”

Samuel R. Staley is director of urban and land-use policy at the Reason Foundation.

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