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Wednesday, September 22, 2010

How to End the Great Recession


It is official: The Great Recession ended – in June 2009. The National Bureau of Economic Research (NBER) says the GDP has risen, which means we are in recovery.

For people who can’t find work, it doesn’t feel like a recovery, and there is good reason for that feeling: This is not a recovery in any meaningful sense of the word. In fact, this economy most likely has not hit bottom.

Obviously, I am at sorts with the “experts” at the NBER and who populate various cubicles and government office buildings in Washington, so I need to explain what I mean. Better yet, I will let economist Robert Higgs explain:

In 2006, gross private domestic investment reached its most recent peak, at $2.33 trillion (in constant 2005 dollars), or 17.4 percent of GDP. After remaining almost at this level in 2007, this measure of investment fell substantially during each of the next two years, reaching $1.59 trillion, or 11.3 percent of GDP, in 2009. This decline is severe enough, but it does not give us all the information we need to gauge the extent of the investment bust.

He continues:

From that level [2006], net private domestic investment plunged during each of the following three years, taking the greatest dive between 2008 and 2009, when it fell to only $54 billion (in constant 2005 dollars), having declined altogether by 94 percent from its 2006 peak! Last year only 3.5 percent of all private investment spending went toward building up the capital stock. Thus, net private investment did not simply fall during the recession; it virtually disappeared. [Emphasis mine.]

The last time the U. S. economy had such a dearth of new net private investment was during the Great Depression. In both cases Higgs blames what he calls “regime uncertainty”: The business community is reluctant and even afraid to invest because it doesn’t know what government will do next.

Higgs points out that the Federal Reserve System has purchased huge blocks of private securities, which may artificially prop up the balance sheets of bailed-out firms, but does absolutely nothing to deal with the larger problem at hand: how to encourage long-term, sustainable private investment. Without that kind of investment the economy will stagnate.

At the same time, government spending has exploded, which only increases the burden that the productive entities must carry. Contra Paul Krugman and the Keynesians, government spending (and especially the kind of spending we have seen in the past few years) is not a net plus to the economy.

Thus if we are to have a real recovery, one that is based on long-term investment that will increase our standard of living, we have to do a number of things, some of which will be politically unpopular. No one in government is willing to endorse activity that might increase unemployment in the short run, but if we want a recovery we have to experience short-term pain.

First and most important, the government and the Fed must stop trying to prop up unprofitable entities from “Government Motors” to the zombie banks on Wall Street. These outfits are draining the economy and no amount of bailout money will change that fact. Second, the government should not be adding to the regulatory burden but withdrawing regulations from our economy.

This economy did not crash because of a lack of regulation, no matter what the political classes tell us. It collapsed because government policies drove huge amounts of resources into lines of production that the economy could not sustain, and until those malinvestments are liquidated or changed to more productive uses, they will continue to consume resources that would be better directed elsewhere.

Third, the government needs to end its debt-ridden ways and go on a real diet.

As noted earlier, what I have suggested is not something the political classes would favor. However, as long as government gobbles resources, the elite will prosper at the expense of everyone else. We cannot have both real prosperity and a gravy train for the political classes.

  • Dr. William Anderson is Professor of Economics at Frostburg State University. He holds a Ph.D in Economics from Auburn University. He is a member of the FEE Faculty Network.