Does the U.S. Need More Growth?

Opinion

on April 23 2013 4:01 PM
U.S. GDP
The more data market-watchers have seen on the U.S. economy, the less they like what they've seen. Specifically, predictions on what the government might report as the rate of GDP growth in the second-quarter of 2012 have plummeted in the past few weeks, as economists adjust their models to one disappointing data release after another. REUTERS

The effect of government debt on economic growth is always a hotly debated topic, and in the past few days the controversy has taken a new turn stemming from a high-profile paper published in 2010.

Economists Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard in their oft-cited 2010 study showed that a high ratio of government debt to GDP is associated with low levels of economic growth. The relevance of the study for the U.S. should be clear, and the paper has indeed been frequently mentioned in the policy arena. But it was only recently that economists managed to replicate the results of the paper, and in the process it was revealed that Reinhart and Rogoff had made some elementary data-entry errors that have thrown their results into question.

Plenty of attention has been devoted to the details of the study itself, but the controversy is more than an obscure academic dispute. It highlights a fundamental problem in the way economists and policymakers think about economic prosperity.

For many decades now, economists have become fixated on the idea of “growth” as the ultimate goal of economic policy and the ultimate measure of economic performance. This fixation often amounts to a kind of mania. Economist Robert Nelson even described the obsession with growth as a kind of secular religion to which all wills must be inclined.

Yet beyond the question of whether growth should be treated as an end in itself, there is the deeper problem of whether growth rates actually reflect real health in the economy. It has long been argued that because growth (expressed in terms of GDP) is measured through aggregate spending, it provides a fundamentally misleading measure of economic life.

What the U.S. needs is not growth, but wealth. Growth is conceived in terms of spending, while wealth reflects the creation of goods and services consumers find valuable. True wealth depends on saving, while growth often rests on (government) profligacy. A telling example of this confusion is that prior to the financial crisis, spending was high and growth seemed reasonably secure. But, of course, the crisis revealed there was little wealth being created in the housing or financial markets, despite what the formal assessments indicated.

The crucial point is that the crisis did not so much destroy wealth as reveal it never existed to begin with. Measures of aggregate performance, especially those focusing on spending, necessarily overlook vital distinctions between sustainable and illusory prosperity. The numbers alone cannot tell us whether spending is actually part of an economic process that improves our welfare.

A question to be asked, then, is not how much we are spending, but what we are spending on. Government spending, especially the “shovel-ready” kind so popular during economic downturns, is essentially waste spending that produces little of discernible, lasting value for the economy. Growth measures, however, are increased by wasteful projects in the same way whether government repairs a road or constructs a golden pyramid.

Contrast this to market performance. Productive and successful entrepreneurs create goods and services that are valued by the members of society. They do not create “growth.” True, productive activity will elicit increased spending, and growth measures will rise as a result. But we must be careful not to put the cart before the horse, or to confuse real economic activity with attempts to measure it.

Sustainable wealth-creation may be more difficult to see and measure than GDP, but it is nonetheless far more important, especially because it is far less misleading. That is in fact one reason why spending aggregates are so often used: They are far easier to observe and to stimulate quickly, and thus more useful for political purposes than encouraging long-term policies for wealth-creation (policies that would also leave less room for political intervention).

In any case, the point remains: In a market free of government privilege, businesses must either find ways to improve welfare, or transfer their wealth to the hands of those who can. No such claim could be made about the effects of government spending.

Markets provide the type of growth to which a society should aspire, a competition between entrepreneurs to see who can best satisfy consumers, as opposed to a government-orchestrated effort to boost some largely arbitrary measures of economic performance. Put this way, the point may seem uncontroversial. But it will take a good deal of effort before economists and policymakers can be reminded of the difference between genuine prosperity and the increasing growth induced by government spending on bread and circuses.

Matt McCaffrey is an instructor of economics at Auburn University and the editor of Libertarian Papers.

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