Recovery Depends on Investment and Capital Accumulation

Some of the feedback I've received on the article "An Economy on Life Support Is Not Recovering" shows a fundamental misunderstanding my critics have about the arguments presented there. In retrospect I see that a more detailed explanation is needed.

In reply to the article there are those who state what the article acknowledges, that Gross Domestic Product (GDP) grew and unemployment dropped from 1933 until 1937. This is taken as proof of the success of the New Deal. Their mistake is thinking that all GDP numbers are equal. They are not, as I explain below.

GDP growth based on private investment in productive capital is the only basis for real growth. In other words companies must invest in factories and other productive facilities (capital accumulation). This investment must come from people's savings, i.e. it must be based on real production, real resources that have been produced. In this way the economy can grow in a realistic and sustainable manner.

When the government spends untold fortunes to stimulate the economy, GDP and unemployment numbers may temporarily improve, but this improvement is illusory. All one does under this scenario is put more money out chasing a stagnant or declining supply of goods and services. The resources used in such a process are not being invested in any kind of productive facilities. On the contrary, productive facilities are being run down to support the make work projects that the government is spending tax money on. (I know that governments also spend money by running deficits, but ultimately the debts must be paid out of tax revenues. Governments can also "print" money, that is paid for with inflation)

As Frank Shostak explains in "What is up with the GDP?":

The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.

For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

I would like to thank Ralph Mullinger for reviewing this article and for his feedback.