Growth for the US economy in the third quarter was the fastest quarterly rise recorded since 1984. Much of the subsequent analysis has focused upon the surge in consumer spending and its presumed role in the impressive numbers. For example, spending on housing rose by 20 percent and spending on consumer durables increased by 27 percent.
A debate has already begun over whether this good news is sustainable. One reality check is the fact that few new jobs are being created since continued increases in consumer spending depend upon employment growth.
However, the primary focus upon consumption is misplaced. Despite the misleading analyses presented on the various media, it turns out that both household spending and job growth depend upon increased business investment.
Think about this for a moment: If you believe that consumption and demand are essential to economic growth, then you must also believe that government spending on armaments and weaponry will boost the economy. (And perhaps you also believe in the the tooth fairy?)
But neither war nor terrorist acts are beneficial to overall economic growth. Were it otherwise, the rebuilding after natural disasters like hurricanes and floods would make them welcome events.
And so it is that the appropriate direction of causation is that production creates the basis of purchasing power that allows consumption to take place. Evidence of this is seen in the fact that those countries with high levels of consumption are those with the highest levels of production.
Non-economists might be forgiven for being misled by commentators that note that consumption spending makes up about 65 percent of total demand. But consumer demand does not drive economic growth.
It turns out that estimates of GDP greatly understate business spending and grossly over-exaggerate consumer spending as a proportion of total economic activity. When calculations of total business expenditures take into account spending between stages of production, it is considerably higher than consumer spending. However, most business spending is left out of GDP calculations because this supposedly would involve double counting.
To reiterate, growth is driven by capital accumulation, not consumption. Increases in productivity that give rise to higher living standards come from capital accumulation. These increases in the material means of production require a stock of real savings. As more capital is accumulated, more can be produced and more can eventually be consumed. And so the really good news is that spending on durable goods over the third quarter was the strongest three-month growth spurt since 1986.
Much of economic policy response is focused upon manipulating the demand side of the economy. This is the aim of the interest rate cuts by the Fed and the expected stimulus effects of eliminating the budget surpluses and replacing them with public-sector deficit spending.
None of these steps can create a sustained rise in the economy. For there to be persistent increases in growth, there must be an increased level of real savings accompanied by technological change and a group of entrepreneurs willing to take risks.
Neither deficit spending nor interest rate cuts nor even temporary tax rebates change fundamentals in the economy. A politician might think that stimulating the economy is a good idea, since it may win votes. But economists should realize that short-run economic stimulus is a misguided idea that leads to long-run losses.
Christopher Lingle is professor of economics at Universidad Francisco Marroque in Guatemala and global strategist for eConoLytics.com.
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