Federal Policies Thwart Economic Recovery

LAS VEGAS—A spirited debate about whether consumer spending or business investment drives the economy left an articulate advocate of each view acknowledging at the FreedomFest conference here that the right federal polices are missing to spur a recovery either way.

With U.S. unemployment close to 10%, the specter of investment-inhibiting tax hikes and runaway federal budget deficits, neither participant in the debate voiced much optimism. Instead, they expressed great concern about the U.S. government’s historically high deficit-spending that is hindering a fledgling economic recovery.

“The current government spending is not sustainable,” said Dave Fessler, an advisory panelist for Investment U., during the debate titled, “What Drives the Economy: Consumer Spending or Business Investment?”

Fessler pointed out that profligate government spending has been taking place well beyond the U.S. borders and is reflected by the debt crises in Greece and other free-spending countries.

Outspending Drunken Sailors
“Governments have been spending like drunken sailors with the false expectation that it will stimulate the economy,” Fessler said. Without increased consumer spending, economic recovery will “flat-line” for some time, he added.

Economist Mark Skousen, who argued that business spending is the key to jump-starting the economy, pointed out that federal budget deficits rose during the administration of President George W. Bush and then soared dramatically when President Barack Obama entered the White House, with Democrats controlling both houses of Congress.

While they agreed on the danger of excess government spending, Fessler defended the view that consumer spending drives economic growth. He cited a Keynesian economic model known as the Paradox of Thrift, which states increased savings reduces production and employment. This situation occurs because decreased consumer spending begins a cycle of reduced employment, further spending cuts and additional unemployment, he added.

To reinforce the view that consumer spending drives the economy, Fessler said the reason Apple has hired more people is because consumers demand its new iPhone and its other innovative products. Without consumer spending, unemployment goes up, as it has done since last year, he continued.

Supply Creates Demand
Skousen countered that saving, investment and capital formation fuel business spending and lead to economic growth. Supply creates demand rather than the other way around, he explained, with consumption becoming a byproduct, not the cause, of prosperity.

Higher savings ultimately will lead to greater investment and prosperity but it does not hold true in a recession, Fessler cautioned. Increased savings is harmful to the economy and stymies the creation of new jobs, he added.

“Businesses are investing in equipment but they are not hiring more people,” Fessler said. In an economic slowdown, there are fewer retail stores and, consequently, a reduced number of people who work in those places, he added.

The path to prosperity and a higher standard of living is on the supply side through increased capital formation, entrepreneurship, technology and inventions, productivity and profitability, countered Skousen, who follows the markets closely as the editor of Forecasts & Strategies, a monthly investment newsletter.

Savings Spur Economic Output
To support his view, Skousen quoted Harvard University economist Greg Mankiw, who is crediting with saying, “The saving rate is a key determinant of economic growth. If the saving rate is high, the economy will have a high level of output. If the saving rate is low, the economy will have a low level of output.”

Although Skousen acknowledged that consumption represents 70% of Gross Domestic Product (GDP), he added that GDP only measures final output and leaves out all intermediate sales that take place prior to retail transactions. Skousen said that Gross Domestic Expenditures (GDE) measure spending at all stages of production, not just final output. Thus, GDE only accounts for about 30% of the economy, Skousen said.

“Consumer spending and retail sales are not leading economic indicators,” Skousen said.

As evidence, he cited the ten leading economic indicators listed by the Conference Board, a global business research organization:

• manufacturers’ new orders
• building permits
• unemployment claims
• average weekly manufacturing hours
• real money supply
• stock prices
• yield curve
• new orders for non-defense capital goods
• vender performance
• Index of consumer expectations

Skousen presented a further finding at the debate last Saturday that indicates business spending drives economic growth in the form of a recent study, “Personal Saving and Economic Growth,” by St. Louis Fed economist Daniel L. Thornton. That study, published December 17, 2009, concluded that a higher saving rate is associated with faster, not slower, economic growth in the current and the next few quarters.

Indeed, businesses make investment decisions based on consumer consumption now and in the years ahead, Skousen explained. The problem with Keynesian economists is that they focus on what is happening now and fail to take future demand into full account, he added.