Monday, November 29, 2010

Economics 101: Why Politicians are Wrong

Thanks to the Center for Freedom and Prosperity for releasing a new video on why economists, the government and the media incorrectly focus on Gross Domestic Product (GDP) as a measure of our nation's economic health.  If more focus was on Gross Domestic Income (GDI), Americans would be better off.

Economic Primer

First, let's give a little primer on what makes up gross domestic product and gross domestic income.

Gross Domestic Product, or GDP is amount of goods and services produced in a year, in a country.  In economic terms, GDP can be calculated by:

GDP = private consumption + gross investment + government spending + (exports − imports)

Gross Domestic Income, or GDI is comprised of national income plus "capital consumption".  In algebraic terms, net national income (NNI) (for educational purposes for this dialogue) is calculated by:

NNI = C + I + G + (NX) + net foreign factor income - indirect taxes - depreciation


* C = Consumption (final purchase of goods and services by individuals constitutes consumption
* I = Investments (everything that remains of total expenditure after consumption, government spending, and net exports are subtracted (i.e. I = GDP - C - G - NX))
* G = Government spending
* NX = net exports (exports minus imports)

Government spending or government expenditure is classified by economists into three main types.[1] Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final consumption expenditure. Government acquisition of goods and services intended to create future benefits, such as infrastructure investment or research spending, is classed as government investment (gross fixed capital formation), which usually is the largest part of the government gross capital formation. Acquisition of goods and services is made through own production by the government (using the government's labour force, fixed assets and purchased goods and services for intermediate consumption) or through purchases of goods and services from market producers. Government expenditures that are not acquisition of goods and services, and instead just represent transfers of money, such as social security payments, are called transfer payments. Government spending can be financed by seigniorage, taxes, or government borrowing. (Source: Wikipedia)
The Video

With Economics 101 behind us, let's watch the video, and the we'll discuss more on why this is important.

More on Why Keynesian Policies Fail

As the video mentions, politicians and economists incorrectly focus on consumer spending rather than focusing on pro-growth policies to spurn economic growth.  What politicians fail to understand is that Keynesian policies that throw government money to grow the economy is short-term, while pro-growth that increase income is long-term.

What this means is that short-term band-aids such as the American Recovery and Reinvestment Act of 2009 (or Stimulus Bill) only aid (if that) the economy in the short-term, rather than encourage or foster long-term real economic growth.  The premise by the Stimulus Bill was to create shovel ready jobs, but in reality when those pet projects are done, they economy will contract again.

Followers of Keynesian economics fail to understand that real economic growth is done in the private sector.  In order for their to be meaningful long-term economic growth, politicians need to focus on pro-growth policies such as: lower tax rates, deregulation, good monetary policy, liberal trade policy and  reduced burden of government spending (see 3:13 of video).

Until politicians abandon Keynesian economics (in favor of Hayek's more business friendly) policies) the American economy will continue to be sluggish.


  1. Under Hayek policy, there's a lot more market volatility, and potentially more growth. Keynesian policy fills the economic dips at the expense of future growth.

    But this isn't necessarily a bad thing. Under Hayek, there could be so much volatility that the whole thing could unravel, as nearly happened in 2008-2009.

    In a democracy, when the economy begins to unravel, the voters get squirrelly. In the 1930's, America swung left, and Germany swung extreme right. Today, the Tea Party is evidence of America swinging right - a direct result of our current economics.

    But the root cause of the 2008-2009 meltdown is neither Hayek policy, nor Keynesian policy. It was deregulation of the banking industry that allowed undisclosed direvetive contracts that nearly brought the system down. WOULD have brought the system down, without Keynesian intervention.

    Give me regulation, I say, to reduce market volititlty, and insure the stability of this country, which we all love.

  2. What happened in 2007-2009 was due to the mortgage crisis, not economic monetary policy. There was no confidence amongst investors and they forced whatever investors remained to be short-term investors. They used day-trading techniques to capture whatever stock price gains existed.

    Some regulation is okay, especially in areas of banking, etc. But overregulation is a deterrant to economic growth.

    Since the last two stock market declines were attributed to the Fed Reserves action or inaction, who is watching them?

  3. Jason, i think you're focusing too much on the stock market. It was the web of unregulated, undisclosed derivative contracts that threatened to topple the economy. The mortgage crisis was only the fuel. The fear came from not knowing which corporations might be insolvent, due to huge, undisclosed derivative obligations. This same fear affected the paper market.

    None of this was possible before derivatives were deregulated at the end of 1999.

    As I said prior, I agree that regulation, any regulation, slows economic growth. But it also helps to smooth the wild economic cycles. Deregulate, and you have bigger booms, and bigger busts. It's during big down cycles that destabilize the nation.

    Modern day Germany's economy is, I think, a good example of successful Keynesian policy. They resisted deregulating and growing their financial sector during the last decade, and they have emerged the strongest nation of the EU.

    China also is successfully practicing Keynesian policy. Just today, after a massive and successful stimulus, China announced a policy shift to slow growth and manage inflation.

    I question the premise of your last statement, "Since the last two stock market declines were attributed to the Fed Reserves action or inaction..." Can you please explain?