Some of the greatest, growth-minded economists in history had names beginning with the letter S: Smith, Schumpeter, and Say. Adam Smith taught us the virtues of free markets and free trade. Joseph Schumpeter placed entrepreneurship and technological innovation at the center of economic growth. And Jean-Baptiste Say understood in 1803 that we produce in order to consume.
Say was also the first to wear that great S-term — supply-sider. He argued correctly that production and consumption are forever tied together, but it is the supply of risk capital and the supply of production that truly lie at the heart of the economy. Here’s how the thinking goes: Business creates production, production creates jobs, and wages for jobs create income. And when producers take time off to become consumers, they use their incomes to spend on goods and services.
So, one could conclude, if the producers are producing at a good rate, there must be a lot right with the economy. Say would agree with this statement in 1803. And we should agree with it today.
The Federal Reserve’s May report on industrial production shows that production in America has increased for the fifth straight month. This statistic alone should put an end to any thoughts that the economy is double-dipping into another recession. But there’s more. Through May this year, the index of industrial production increased at a 4.6% annual rate. A year ago, production was declining at a 5.8% annual rate. The upswing in production informs the upturn in the economy.
Down through the years, the industrial-production index has proven to be the most valuable coincident indicator of the economy. Back in late 1982, the first monthly gain of the index signaled the end of the nightmarish inflationary recession inherited by Ronald Reagan. Through the Johnson, Nixon, Ford, and Carter administrations, the Keynesian mistakes of taxing, spending, inflating, and regulating piled up. But Reagan arrived in 1980, growth-guns blazing.
Reagan promoted a sound dollar to conquer inflation and lower tax-rates to spur production and consumption. The Gipper’s tax-cut plan became fully effective in early 1983, and the economy took off. The first signal of that growth? The Fed’s index of industrial production, which rose in December 1982 after failing to grow for four years. The index increased for nearly the next two decades.
The stock market malaise from corporate corruption, accounting fraud, and fears of an imminent terrorist attack on the U.S. remains a big problem today. But as long as industrial production is rising, workers will have more jobs, consumers will have more income, retailers and department stores will benefit from higher sales, and the economy will continue to recover.
Expanding production also generates more income for the businesses that are producing the goods and services that will ultimately be consumed. Though few commentators seem to notice, economic profits in the national income accounts that we call GDP have increased 19% over the past two quarters. The current stock market funk cannot last if production and profits are on the rise.
Inside the production index, technology is the fastest-growing sector. But it seems we’ve forgotten our Schumpeter. Technology remains the least popular stock-market area today, although the output of new computers, communications equipment, and semi-conductors have increased for six consecutive months. For the three months ending in May, tech production has registered a 15.5% annual gain.
Jean-Baptiste Say would be proud. He would laugh at demand-side economists who keep telling us the consumer is slumping. He would argue that production is the heart of the economy, not consumption. He would reason that if it is profitable to produce, after tax, then gains in the supply of production will soon lead to increases in the volume of consumption.
Of course, government can get in the way of the free market, which is where — Adam Smith taught us — growth begins. The Bush administration’s tariff on steel, for example, is raising the cost and blunting the production of this valuable commodity. It is the president’s worst mistake.
Fortunately, the tax cost of most production in the U.S. has been reduced by Federal laws to lower tax rates on individuals and businesses. In addition, the Fed is feeding more cash into the economic pipeline, removing the deflationary constraint on production.
On the world stage, the president is readying plans to transform the evil government of Iraq, a move that will ensure greater domestic security. Consequently American businesses will remain open for production, and individual producers will get home to their families safely in the evening. Smith, Schumpeter, and Say would all approve.