Taking, not making

Slowly, almost imperceptibly, our economy has changed from a dynamic growth economy into a non-growth, tired and spent welfare state. The implications of this change are enormous and should be recognized by investors, taxpayers and anyone else who will pay in one way or another for this change. There are at least three reasons why our economy has reached this point.

1. Growth in Government Employees

Stephen Moore in the WSJ
describes why our economy is stagnant and will remain so:

If you want to understand better why so many states-from New York to Wisconsin to California-are teetering on the brink of bankruptcy, consider this depressing statistic: Today in America there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million). This is an almost exact reversal of the situation in 1960, when there were 15 million workers in manufacturing and 8.7 million collecting a paycheck from the government.

Other data on the economy are "noise" compared to those above. Employment and GDP are not unimportant, however, their potential is restricted in our new economy. Inflation is also more likely in an economy that is government-dominated and government-managed.

The employment mix referred to by Mr. Moore limits our economy to mediocrity. At best, the economy will be relegated to the sclerosis that has characterized the European Welfare States for the past two or three decades. Structural limits now constrain the economy. These limits show up in lower growth rates and standards of living.

To understand why, the late Henry Hazlitt provides some perspective. He did not like the terms "private" and "public" sectors. He accepted the dichotomy, but preferred the terms "productive" and "unproductive." The government produces nothing tangible. It does not create wealth, it destroys wealth. Limited to its original task of internal and external defense, it could be argued that government produces service for the productive sector. But even here, it squanders resources, harming the economy via inefficiency and overspending. Arguably, all else the government does is unproductive.

2. Transfer Payments

As government grows larger relative to the productive sector of the economy, fewer workers produce less wealth. Mr. Moore's focus on employment between government and the productive sector is a proxy for the harm done by government. Yet the costs of government go well beyond this proxy. Not captured are the resources taken from the productive sector to support transfer payments to the unproductive (unemployed, retired, etc.). In 1969 government social benefits paid as a percentage of personal consumption were 3%. By 2010, they had increased to almost 25%. This astounding growth in welfare comes at the expense of the productive sector.

3. Regulation

Perhaps more damaging to the economy is regulation.  Richard W. Rahn states:

The direct government costs of regulation are tiny compared to the costs on the private sector, which have been estimated by economists to be, on average, approximately $20 for each dollar the government spends, or something more than $1 trillion and roughly 15 percent of the U.S. GDP.

If the growth of the regulatory state is not brought under control, we will lose both our liberty and our prosperity

These costs are not seen in government accounting statements, yet they represent massive cost imposed on the productive sector of the economy. They are dead-weight costs in the sense that most presumably would not be undertaken in order to produce product or wealth. If they were deemed worthwhile by business, there would be no need for coercion. 

Recognizing the drag from transfer payments and regulations is not to disagree with all of these costs. People differ on how much social support and regulation is worthwhile. My personal opinion is that most of it is harmful, but arguing the point is not very productive. Those holding the opposite extreme view are driven more by ideology than costs and benefits. 

What should be understood is that as more of these costs are imposed on the productive sector of the economy the poorer a nation becomes, at least relative to its potential. Less wealth and product is the end result. Living standards are lowered. 

As Mr. Moore indicated, we have shifted from a nation of makers to a nation of takers. Unfortunately that is not conducive to easier and better living, at least for the productive people in society. When the rewards for not working begin to approach the rewards for effort, society is finished.

Monty Pelerin at www.economicnoise.com