Saturday, April 28, 2012

Why Economic Growth Has Been So Low

As many of our clients and prospective clients know, we frequently discuss the strength of the corporate sector of the economy. As the below chart shows, corporate profit growth has continued to strengthen.

From The Blog of HORAN Capital Advisors

With this level of corporate profit strength, one has to ask why economic growth (GDP) has not been stronger. The first report on first quarter GDP Friday indicated growth was running at 2.2% versus expectations of 2.5%. A recent post at the blog, Calafia Beach Pundit and written by Scott Grannis, the former Chief Economist at Western Asset Management, notes the drag the government sector is having on economic growth:
"Here's another way of appreciating what has happened in recent years. The private sector has been working very hard to increase its efficiency and its output, and that shows up in the record level of corporate profits, both in nominal terms and relative to GDP. But instead of allowing or encouraging the private sector to plow those profits back into the economy in the form of new plant and equipment, new jobs, and new technologies, the federal government has effectively borrowed all the corporate profits generated since 2009 and distributed the money to the unemployed, to the poor, to favored "green" industries, to unions, to state and local governments, and to "make-work projects," among other things. There's been a lot of money thrown around, but lots of it has been wasted in the process that could have been put to better use; we simply don't have much to show for the $1.25 trillion of after-tax profits generated per year on average by U.S. businesses since 2009. (I'm referring here to the fact that federal deficits in recent years have been roughly equivalent to after-tax corporate profits—actually a bit higher. So on a "sources and uses of funds" basis, the government has effectively used all corporate profits to fund its spending.)"
GDP is commonly defined as:

GDP = C + I + G + (X - M)

  • C = private consumption
  • I = gross investment
  • G = government spending
  • (X - M) = exports - imports
Government expenditures on final goods and services includes salaries of public employees, purchases of military equipment and any investment expenditure by the government. It does not include transfer payments, such as social security or unemployment benefits.

As Scott Grannis notes in his article, there are many aspects of government expenditures that have not been additive to U.S. economic growth in spite of the strength in the corporate sector of the economy.

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