Boosting Growth

  By John T. Harding

 It's a simple equation, taught in every Econ 101 course: Gross Domestic Product equals Consumption plus Investment plus Government expenditures plus Net Exports (Exports minus Imports). Expressed as a formula, it looks like this:

GDP = C+ I + G + (Ex-Im)

   The economy grows when GDP grows. When the economy (GDP) recedes, one or more of the contributing factors can be leveraged to get the economy growing again. The question then becomes, which one? Since Consumption accounts for some 80 percent of the economy, this is usually the target to encourage a recovery. In turn, this raises the question from which one, to how to use the other factors to push Consumption out of its rut.
   Classical economics of the 19th Century says leave things alone, and eventually consumers will start buying more stuff. Thus, the economy recovers.
   The "trickle-down" theory of the Reagan years pointed to Investment as the best lever, and claimed the way to encourage leverage is through tax breaks or lower interest rates, thus making investment in additional production capacity more attractive.
   Keynesians believe Government should step in, stimulating growth by increasing its expenditures, especially in situations where laissez-faire or trickle-down strategies don't succeed.
   Finally, devaluing a currency can make Exports less expensive for overseas buyers, thus increasing sales.


   Let's consider each strategy.
   "Eventually" can be a long time, so the strategy of non-intervention can leave a large part of the population -- except for the very wealthy -- in economic pain for many months, if not years. An example here is the Great Depression of the 1930s.
   Tax breaks for the wealthy are not enough to boost the overall economy, since they spend plenty as it is, and making even more money  available to them is no guarantee they will actually spend it on additional consumption. Instead, the extra money is likely to be stashed in a safe banking haven.
   Granted, this makes more money available for Investment, but if bankers are reluctant to lend and manufacturers reluctant to borrow for additional capacity because the economy is in a rut, (Why make more stuff if nobody's buying anyway?) lower interest rates may not help. This is the current problem. Interest rates are already near zero, so increasing the money supply will only cause inflation. Moreover, credit card interest rates remain as high as 25 percent, so many consumers are paying down this debt rather than buy more stuff.
   Devaluing a currency is politically unpalatable, and in any case, Net Exports don't amount to a large enough portion of GDP to make a significant difference. Moreover, in a declining world economy, consumers in other countries are also pinched for cash.
   That leaves the strategy proposed by economist John Maynard Keynes during the Great Depression. If no other strategy is increasing the flow of goods and services (GDP), Government can and should step in to "prime the pump," pouring money into things like infrastructure improvements, thus providing jobs and wages so workers can pay for food, clothing, shelter and whatever extras they may want.
   This strategy worked in the 1930s, and can work again today if the government avoids the mistake of 1936-37, when government pulled back too soon on expenditures, causing another dip in the economy. It took the onset of World War II, with astronomical government spending, to finally end the Great Depression. With care, the current administration in Washington can continue its stimulus program without the trauma of a major war.


   One danger, of course, is that pumping more money into the economy will bring higher prices. (This happened in the 1940s, but once again, government intervened with a price control program.) As economist Milton Friedman so succinctly put it, "Inflation is always and everywhere a monetary phenomenon."
   Or, put less formally by our resident philosopher Pug Mahoney, "Prices rise to absorb the amount of money available. Ask any tourist."
   Doing nothing, however, is not an acceptable option.
   Granted, inflating the money supply increases the risk of a sharp rise in prices, but the wealthy will have an incentive to buy now before prices rise even higher, and the unwealthy -- those working in the shops where the wealthy buy -- will have wages to pay for more basic needs.
   And finally, once the economy is rolling again, government expenditures can be scaled back and those who control the money supply can reduce it, thereby stabilizing prices.