According to the National Bureau of Economic Research, the United States has enjoyed its longest expansion. Starting in June 2009, our Gross Domestic Product has grown 25%. We now enjoy a 3.5% unemployment rate, a 50-year low.
Economies grow because of increases in the production of goods and services. There are four major factors that contribute to growth.
First of all, a high level of consumption provides an economic incentive for businesses to expend more on plant and equipment and increase their workforce. Having more workers results in higher consumption because people spend more than 90% of their income.
Secondly, government expenditures stimulate growth, particularly when spending focuses on the infrastructure — roads, bridges, research, etc.
Thirdly, to the extent that we increase exports, companies all things being equal will spend more on capital investment and hire more workers.
Lastly, the role of business investment is essential in a capitalistic economy for economic growth. Although business investment only represents about 10% of the U.S. economy, it is a primary driver of innovations and technological advances. That is, capital investment — the acquisition of long-term assets such as real estate, manufacturing plants, and machinery — are the building blocks for sustained long term economic growth.
The United States has benefitted substantially from the expansion of our shale oil production. Until this development, U.S. oil production was declining. We now are the biggest oil producer in the world.
The advent of the internet has brought new technologies such as e-commerce and revolutionized how business was done. When I studied economics, we recognized the practical limitations of getting the best product at the best price because our buying options were limited. The internet has geometrically widened our ability. In brief, Amazon has fundamentally changed the way Americans shop.
In a developed economy such as the United States, our annual rate of growth has historically averaged about 2% in the post World War II era. There are several factors that keep our growth rate relatively small. First of all, much of capital expenditure depreciates. Thus, we need to spend money to prevent our roofs from leaking, our machinery functioning, stop plumbing leaks, etc. Secondly, we can only afford to invest from the proceeds of saving. Savings provide the funds to make the necessary purchases and investments required for economic expansion.
We need to differentiate between money spent on consumption and money spent to purchase capital goods. While we all enjoy a good meal or buying a beautiful coat, these expenditures do not facilitate economic growth.
Capital investments, which are long term, include items such as factories, machines, computers, vehicles and other production equipment. They increase labor productivity and make work effort more efficient. In general, unlike food that provides immediate nourishment, capital investments generally do not provide immediate increase in revenue. In order to make a capital investment, companies either need to dip into savings, borrow funds or sell stock. Over time, capital investments in the aggregate lead to economic growth
During the Great Depression, the great economist John Maynard Keynes made a key observation. Until his breakthrough ideas, economists assumed that if interest rates declined enough, businesses were willing to borrow to make capital expenditures and hire more people. Keynes recognized that because the outlook was so dire, business executives were afraid to either borrow or dip into their cash reserves. In the absence of spending, world economic activity declined and unemployment soared. Keynes advocated that to jump-start the economy, government needed to borrow funds and finance programs such as the WPA and Tennessee Valley Authority. Our massive spending for armaments during World War II boosted factory output. Moreover, putting 10 million people in the armed services increased significantly consumer spending. This in turn encouraged businesses to expand.
Originally published in the Sarasota Herald-Tribune
