While most Americans are familiar with the broad ups and downs of the economy and the job marketthe stuff of daily headlinesthe deeper story of the continuing recession can be found buried in the statistical appendix to the 2010 report of the presidents Council of Economic Advisers.
That story: a devastating decline in investment spending.
The governments data reveal that, contrary to popular belief, consumer spending held up fairly well during the recession, falling less than 2% from the fourth quarter of 2007 to the second quarter of 09.
Most of this decline was erased during the third and fourth quarters of 2009, so by the final quarter of last year real private consumption spending was less than 1% below its previous quarterly peak.
Although the drop in private consumption spending obviously contributed to the recession, the drop in private investment spendingprimarily business purchases of structures, equipment, software and additions to inventorieswas far more significant.
Gross private domestic investment peaked in 2006. Between the first quarter of that year and the second quarter of 2009, it fell precipitously, by nearly 34%.
During the second half of 2009, investment spending increased by only 10%, so that late last year it was still (when measured at an annual rate) running 29% below its early 2006 level.
This huge decline in investment spending portends an extended period of slow economic growth, lasting several years and perhaps longer. Worn-out equipment, obsolete software, ill-maintained structures and depleted inventories are not the stuff of which rapid, sustained economic growth is made.
The current investment drought does not simply reflect the housing bust that followed the residential investment boom that peaked in 2005. To be sure, real residential investment fell tremendously, by almost 53% from 2005 to 2009, with especially rapid declines the past three years. Yet real nonresidential investment also fell greatly last year, by 18% from its 2008 peak.
Even real investment in equipment and softwarea category only loosely connected to the housing boom and bustdeclined last year by 17% after occupying a high plateau during the preceding three years. Business firms have also fled from inventory investment, trimming their holdings by an unprecedented $125 billion in 2009 after lopping off $35 billion in 2008.
Federal government spending, meanwhile, has raced ahead. From 2007 to 2009, government purchases of newly produced final goods and servicesthe federal governments contribution to GDPincreased by over 13% in constant dollars.
Unfortunately, while private investment is the engine of economic growth, government spending (despite what generations of Keynesian economists have asserted) is the brake. To understand this negative relationship, we need only scrutinize how the federal governments spending is determined: namely, by political processes devoid of economic rationality.
In this light, we can appreciate that enhanced government spending does not bulk up the economy, nor merely crowd out worthwhile private activity. Instead, it undercuts, penalizes and distorts everything that private parties attempt to do to create wealth. Ham-fisted government regulations and additional taxes are known killers of economic growth.
The investors famine and the governments feast therefore are not merely coincidental, but causally connected.
Making matters worse, the explosion of the federal governments size, scope and power since mid-2008 has created enormous uncertainties among investors.
New taxes and higher rates of old taxes; potentially large burdens of compliance with new environmental and energy regulations and mandatory health care expenses; new, intrinsically arbitrary government oversight of systemic risks associated with virtually any type of businessall of these unsettling possibilities must give pause to anyone considering a long-term investment.
Investors now face regime uncertainty to an extent that few have experienced. To find anything comparable, one must go back to the 1930s and 1940s, when the menacing clouds of the New Deal and World War II darkened the economic horizon.
Unless Washington acts soon to resolve these uncertainties, from the cap-and-trade folly to the health care monstrosity, most investors will likely remain largely on the sidelines, consuming some of what would have been invested and protecting the remainder of their wealth in cash hoards and low-risk, low-return, short-term investments.
If this destructive stalemate persists much longer, Americans may have to write off another lost decade for much the same reason they suffered the first one during the 1930s.
Robert Higgs is Senior Fellow in Political Economy at The Independent Institute and Editor at Large of the Institutes quarterly journal The Independent Review. He received his Ph.D. in economics from Johns Hopkins University, and he has taught at the University of Washington, Lafayette College, Seattle University, and the University of Economics, Prague. He has been a visiting scholar at Oxford University and Stanford University, and a fellow for the Hoover Institution and the National Science Foundation. He is the author of many books, including Depression, War, and Cold War.
Full Biography and Recent Publications