Business Insider

Peter Crabb: Only investment will boost the U.S. economy in the long run

It’s official – the economy is hurting. But wait just a minute: It is different this time.

The commonly used definition of recession looks at production of goods and services produced throughout the country. When gross domestic product declines for two consecutive quarters, it is said the economy is in a recession.

For this announcement, however, the National Bureau of Economic Research (NBER) looked at much more than just the change in economic output. The committee of economists considered monthly employment figures, industrial production and personal income, among other criteria.

The employment picture looks the worst. Nonfarm payroll levels have declined all year. The work force of the financial and construction industries is significantly smaller.

A smaller work force does not always mean lower output. It is possible we will see stable economic output as measured by GDP even when employment is declining.

GDP is made up of four components – consumer spending, investment, government purchases, and net exports.

By the traditional definition, we are not in a recession because we have had only one quarter of lower GDP. The preliminary report for the third quarter of 2008 showed the economy receded at a real annual rate of 0.5%, primarily due to just one of the four components — lower consumer spending.

For 2008, we could still see positive economic growth if government expenditures and continued increases in net exports offset slower investment and consumer spending.

While possible, the outcome is unlikely given the dramatic cutbacks we are seeing in consumer spending. The latest sales numbers for the auto industry paint a bleak picture.

In November, General Motors' sales were down more than 40 percent. Chrysler's sales were down 47 percent and Ford's were off 31 percent. Even foreign automakers are seeing a steep drop in U.S. sales with Toyota and Honda falling 34 and 32 percent, respectively.

In the longer run, however, consumer spending does not help us out. Buying more cars may help that industry and national employment numbers, but only an increase in investment can truly raise our standards of living over time.

A fundamental lesson about the economy as a whole is that productivity is the ultimate source of living standards. Productivity rises only if fewer workers produce the same amount, or more, goods and services.

We should also remember that unemployment is the effect, not the cause, of our economic misery. We should not be surprised by the decline in employment given the sharp drop in business investment experienced these past two years.

We must also remember Okun’s law, named for Arthur Okun, an economic adviser to President Lyndon Johnson. Okun’s Law shows that output grows relatively more rapidly than employment as an economy begins to recover from a recession. Thus, we will almost certainly see GDP growth with continuing lower payroll numbers as the “employment” recession we are now in comes to an end.

Policy responses to the current economic problems will do more in the long run if they look to increase investment, not spending. Only higher investment levels can increase employment and improve the longer-run outlook.

Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.