U.S. economic strength makes it world power

The events in Ukraine have naturally moved our attention to geopolitics, strategic options and Russia’s renewed interest in the restoration of its footprint to pre-breakup, Soviet Union size. It wouldn’t seem that this issue would have much in common with the most recent economic forecast from the Congressional Budget Office, but they are very closely related ­— perhaps more than we would like.

By the CBO’s calculation, the U.S. economy will continue to grow, and at an improved rate, for the next few years — through 2017 — but will still remain under capacity. That will mean a painfully slow improvement in the unemployment rate, which will not shrink to 5.5 percent until 2024. According to the forecast, the discouraging jobs picture will slow any improvement in the labor force participation rate.

Particularly discouraging is the CBO’s assessment that, “Over the next decade, potential output is projected to grow by 2.1 percent per year, on average, which is much lower than the average rate since 1950.”

What this boils down to is that even if we manage to reach our full economic potential, it’s going to be a lower growth in output than we, our parents, and our grandparents had enjoyed.

The CBO gives three reasons for this slowdown in potential. The first is the slowdown in the growth of the labor force attributed to the aging of the baby boomers. Second is what it describes as the “lingering effects of the recent recession and slow recovery.” And the third reason is the effect of the “federal tax and spending policies written into current law.”

Each of these reasons deserves a book-length treatment, but there is also a fourth possible reason that deserves our attention: an economic budget, showing what we can afford.

Following usual practice in the economics profession, the CBO’s forecast uses Gross Domestic Product as its measure of growth. GDP, though, is an accounting summation, part of our system of national accounts, and that is the source of both its strength and its limitations.

Accounting systems are not value systems. They simply “follow the money” by aggregating the transactions and seeing what it was spent on. The size of the GDP is determined by how much money we spend, not on the qualities of what we spend it on.

The implications of that value-free characteristic become significant in issues of fiscal policy. In Keynesian economic theory, for example, it doesn’t matter what the government spends deficit-financed stimulus money on; the economic boost is the same. This is true in the accounting sense — the GDP will expand by the additional amount spent by the government — but fails the test of reasonableness. Despite identical accounting effects on GDP, for example, our choice between building a bridge between two interdependent communities or setting off explosives out in the desert somewhere will certainly have different economic effects.

The economic question, then, is this: If it makes a difference what money is spent on, what happens to economic growth if a society becomes more self-absorbed and prone to instant gratification? In a free market system more money will be spent on things that reflect the society’s changing priorities. Savings would play a smaller role in household budgets, and we would see rising expenditures on entertainment, games and other products and services that affect GDP from an accounting, but not an economic, standpoint. These expenditures are the “empty calories” of our economy.

There is nothing wrong with some empty calories once in a while, but our bodies set limits on how much is good for us. In the same way, an economy sets limits on expenditures that have limited economic effect even if the accounting system does not reveal them. The first indication that something is wrong may turn up in the economic growth rate and sectors driving it.

The leading sectors in our economic growth forecast, for example, are education and health care, both of which have productivity issues and, at best, unclear net impacts on economic growth. Their size and growth are dependent on the ability of our economy to afford them.

Much the same can be said about our military sector, which brings us back to the range of options available options in the Ukrainian situation. This may very well be the 21st century but the world’s nations, including our adversaries, remain impressed by an ability to deploy effective military resources. It is a significant peacekeeping resource. Our continued ability to do so is directly affected by our economy’s capacity to afford it — and that means economic growth.

Ours is a bountiful economy in which many good things are possible and affordable. We need a better understanding of economic growth to keep it that way.

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