Thursday, August 7, 2003

The latest GDP report of 2.4 percent real growth in the second quarter of this year is good news for the American economy and reduces fears of a dreaded double-dip recession. Caroline Baum of Bloomberg notes that this stronger-than-expected GDP growth confounded most economists, who had been much less bullish on the U.S. economy.

There were nuggets of good news in the Commerce Department report: Private domestic investment is up, and equipment and software purchases increased a solid 7 percent, the largest increase since 2000, signaling that perhaps the long-awaited supply-side recovery is now under way. Combined with strong demand growth of 3.3 percent, the economy seems on the verge of an accelerated recovery.

But the bad news is that GDP itself is still a grossly misleading way of measuring the state of the national economy, as economist Lawrence Kudlow had pointed out many times on these pages.

The headline-grabbing number of 2.4 percent growth, immediately applauded throughout the media as strong, is about double the real rate that the private economy grew. While the private economy grew at about 1.3 percent, the federal government component of GDP increased by a staggering 25 percent, the largest quarterly increase in more than three decades. The increase was due almost entirely to the high cost of the war in Iraq. But even domestic agencies saw growth in their budgets far surpassing private sector growth.

The important word here is “cost.” Wars are a cost, not an asset.

You fight wars because you have to — because there are bad people in the world. But to suggest the war was good for the economy would be as dimwitted as suggesting Saddam Hussein deserves a medal of honor for helping revive the U.S. economy.

Defending U.S. interests militarily is a legitimate and necessary function of government, but it eats up resources and reduces growth, rather than enhancing it. So to a large extent, the growth reported this past quarter is a statistical mirage. The way we currently measure GDP makes billions of dollars spent look on military expenditures look like productive economic activity.

We should stop counting government growth in GDP. John Maynard Keynes was wrong, after all, when he said government spending stimulates a strong economy.

We now know government growth does not enhance a free market economy; it crowds out productive private enterprise and production of wealth-enhancing goods and services. This convention of counting government spending as an asset rather than a liability creates the illusion that bigger government means more prosperity. Where on Earth has that ever been the case? Certainly not the former U.S.S.R., East Germany, Japan or Argentina.

The dramatic expansion of government we have seen in the United States over the past century no doubt had some positive benefits. The government builds roads and schools and spends money on our national defense and police and fire service. The problem is that many of the goods produced in the public sector add little value to the wealth of the citizenry. These are goods and services demanded by politicians, not by willing consumers in the free marketplace.

The real resources in the economy captured by government for additional public sector spending can only come from three sources: taxes, debt or inflation. The build-up of any one of these funding sources can have influenza effects on a capitalistic economy. In the 1970s, all three accelerated at once, and the U.S. industrial economy collapsed until rescued by Ronald Reagan’s supply-side and limited-government ideas.

In 2001 and 2002, the government component of GDP was growing about 4 percent yearly, whereas private businesses increased their output by less than 1 percent. Since most Americans are employed by private businesses, not government, and since more than half of American workers are also stockholders and thus owners of the private-sector corporations in America, the growth of government does not make America’s workers feel more prosperous in any way.

Continual growth in government, one of the key components of GDP, probably does more harm than good for our private-sector-driven high-technology economy. Government growth does not drive productivity. It does not rally the stock market. It does not put more Americans to work (unless they work for the government itself). And it does not raise incomes of workers (in fact, because it necessitates higher taxes, it reduces take-home pay).

Here is our proposal: The conventional GDP numbers should be replaced with Private-Sector GDP. Private-Sector GDP would omit government spending from the calculations. This would allow us to measure how much the market-based economy is expanding over time. By excluding government spending, no longer would economists and policymakers automatically assume the Keynesian theory that increasing government spending increases economic output.

Let’s measure GDP correctly. Activities that add to wealth should be included; expenditures that reduce wealth excluded. Sorry, but when we calculate economic growth correctly, our performance is still underwhelming. We would make the case that the single most productive thing Congress could do to revive prosperity and jobs would be to cut government spending as much as possible. By all means, bring a chain saw.

But this advice is exactly the exactly the opposite of what the GDP calculators would tell us to do. The New York Times just published a Page One story arguing that the reduction in state and local government spending this year is having a contractionary effect on the U.S. economy. Here we have the perfect example of how statistics lie and liars figure.

Stephen Moore is president of the Club for Growth. Phil Kerpen is a research assistant at the Club for Growth.

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