Economist Scott Grannis writes in his excellent blog, Calafia Beach Pundit Thoughts on Why Real Growth Has Been Disappointingly Slow, 4/27/12.
As a corollary, while central banks have the ultimate control over our inflation destinies, they have very little ability to create real growth. Good monetary policy can contribute to growth by promoting the stability of a currency and thus bolstering the confidence of investors, but it can’t just create growth out of thin air by artificially lowering interest rates or running the printing presses. In the end, real growth only occurs when the resources available to the economy (e.g., capital, labor, raw materials) are put to work in a manner which increases total output.
The federal government is also very limited in its ability to generate real growth, since spending money on more bureaucrats or more transfer payments doesn’t do anything to create more output, and more likely results in greater inefficiency and thus less output. Generating more output from scarce resources is where the private sector excels. It’s hard for an entrepreneur to figure out get more out of a given amount of resources, and working more hours is hard too. Working hard or harder generally requires giving people an incentive to do so, and the profit motive operating in free markets is what has proven to work best.
So if we’re looking for a reason why the economy is 12% smaller than it otherwise should be, we shouldn’t be looking at the Fed. I think one obvious source of the shortfall is the huge increase in government spending in recent years, most of which has been in the form of transfer payments. Instead of allowing the private sector to utilize the trillions of dollars the federal government has borrowed to fund this increased spending, the government has effectively just taken the money from the pockets of those who have been productive and put it into the pockets of those who have been unproductive or less productive. That doesn’t create growth, it just wastes our scarce resources, because—as Milton Friedman taught us—nobody spends other people’s money as wisely as they spend their own money. It’s as if the government simply directed all of us to pour some of our hard-earned money down the toilet by buying things we don’t need.
Here’s another way of appreciating what has happened in recent years. The private sector has been working very hard to increase its efficiency and its output, and that shows up in the record level of corporate profits, both in nominal terms and relative to GDP (see charts above). But instead of allowing or encouraging the private sector to plow those profits back into the economy in the form of new plant and equipment, new jobs, and new technologies, the federal government has effectively borrowed all the corporate profits generated since 2009 and distributed the money to the unemployed, to the poor, to favored “green” industries, to unions, to state and local governments, and to “make-work projects,” among other things. There’s been a lot of money thrown around, but lots of it has been wasted in the process that could have been put to better use; we simply don’t have much to show for the $1.25 trillion of after-tax profits generated per year on average by U.S. businesses since 2009. (I’m referring here to the fact that federal deficits in recent years have been roughly equivalent to after-tax corporate profits—actually a bit higher. So on a “sources and uses of funds” basis, the government has effectively used all corporate profits to fund its spending.)
Grannis offers an explanation of why the stock market has been performing well yet the economy still is mired in slow growth and unemployment. It is like a business that spends it capital on fancy office furniture and first class travel instead of improving its productive efficiency and customer service. The Keynesian idea that the effectiveness of stimulus spending is largely irrelevant to how it is spent is hogwash. I am not certain Keynes himself would have argued that it is irrelevant, but his heirs such as Paul Krugman certainly have. The pinnacle of this absurdity is Nancy Pelosi’s ridiculous statement that unemployment benefits are productive investments.
Other friction costs such as taxes, mandates and regulations also kill economic growth. We simply cannot grow an economy by creating incentives not to invest and produce and creating and expanding expensive benefits that are an incentive not to work. By this point in the recovery we should be back on the same mean pattern of growth, yet we are far short. Monetary policy can no longer cover for fiscal policies and regulations that stifle growth.