- The Washington Times - Sunday, August 5, 2001

Virtually unnoticed by the media, the latest government economic report on the nation's gross domestic product for the April-June quarter revealed that the heart of the U.S. economy has slipped into recession.

In fact, this marks the second consecutive quarterly decline for the private sector economy.

Although the official figures cited a tiny 0.7 percent annual rise in overall real GDP, just barely above the water line, this positive total was made possible only by a $22 billion rise, calculated as a 5.5 percent yearly rate of increase, in federal, state and local spending. Take that out, and then you have a new category called adjusted real gross domestic purchases. This measure of private sector consumption and investment actually declined at a 0.1 percent annual rate.

During the prior January-March quarter the story was similar. Overall gross domestic product adjusted for inflation increased at a slow 1.3 percent annual rate, but even this near-recession number was artificially boosted by a $21 billion government-spending boost. Without it, adjusted real gross domestic purchases (which excludes trade and government) actually declined by 0.2 percent annually.

In other words, the productive sector of the U.S. economy has been sinking for six months, actually falling $6 billion from $8.112 trillion in last year's fourth quarter to $8.106 trillion in this year's second quarter. It's a recession. The headlines don't tell this recession story, but it's the real story. Stock market investors have known it for over a year. People in business know it as inventories and jobs have been slashed.

These totals exclude government spending, whose rising tax cost disincentives absorb productive resources and detract from economic vitality. The figures also remove the so-called net export sector (exports minus imports), whose inaccurate accounting practices frequently mask real economic trends. The focus here is on the domestic private sector. That's the heart of the economic story.

Private sector real GDP (adjusted for inflation, excluding government pump-priming), accounts for 83 percent of total economic output. All of the nation's industrial production and business investment comes from the private sector. And 85 percent of the country's 132 million jobs are created privately.

Squeezed by an incredibly harsh Federal Reserve policy that deflated the basic money supply, the stock market, commodities and everything else in its path, and a series of OPEC-induced energy price shocks, the economic carnage in the private sector continues to mount. In just 18 months the growth rate of inflation-adjusted private domestic purchases has swung from plus 8 percent to minus 0.2 percent. Nothing like this has occurred since the early1980s.

In the business sector, the rate of change of investment in equipment and software has plunged to a negative 141/2 percent from a positive 18 percent Cumulatively over the past three quarters the level of business investment has dropped 5 percent, while industrial production has fallen 41/2 percent Over the past year, corporate profits have declined 21 percent. Even consumer spending growth, a mainstay of this recession cycle, has eased down to 2 percent from 6 percent.

Adding to the economic malaise, the Federal Reserve has forced more than 50 percent of banks to tighten their business loan standards. Meanwhile, the venture capital flow the real money supply for the wired economy has dropped more than 60 percent during the past year. Without a sufficient supply of risk capital and bank credit, entrepreneurship and innovation is left dead in the water.

Technology breakthroughs that might unleash a productivity-enhancing flood of job-creating new business formations go unfunded.

You might say, "It's the private sector, stupid." Or, even better, "It's the business sector, stupid." America's principal business is the creation of business. Businesses, not government, create jobs. Capital, not government, creates businesses. If the climate for risk capital, bank credit and new business creation is positive, then the economy soars.

But the latest GDP figures tell us that it's government spending, stupid. While the private sector is sinking, government is soaring. Big public sector spending is keeping GDP in positive territory, misleading some into thinking the economy is really OK, just suffering from a temporary correction.

Surprisingly, it is state and local government spending growing at a 7 percent rate this year that is providing artificial stimulus to GDP. Federal purchases have actually slowed to 11/2 percent growth this spring, down from nearly 5 percent last autumn.

Just as surely as day follows night, rising government spending at any level leads to higher tax burdens. Since taxes are inversely related to economic growth, this is surely a negative omen for the future economy. The GDP accounts score spending as a net economic plus. But producers and investors in the business economy know otherwise. If the tax cost of investment, production and job creation goes up, then real economic activity will go down.

What the recent GDP figures really tell us is that we have a private economy recession and a government economy prosperity. In order to achieve long-run economic growth, however, what we really need is a government recession and a private prosperity.

President Bush has already reduced personal tax-rates, and hopefully he will move to lower investment and business taxes as well. The Fed should heed the message of deflating commodity markets and inject substantially more liquidity into the economy. Then the big question is whether the nation's governors and mayors will follow Mr. Bush's lead. So far they haven't, and that's one reason why private GDP is in recession.

Lawrence Kudlow is a nationally syndicated columnist.

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