President Obama on Tuesday night stressed U.S. economic competitiveness as a new policy theme, accentuating the point he made last week by naming General Electric CEO Jeffrey Immelt to lead his new jobs council. This is welcome, though not solely because it may signal less Administration hostility to business. The pairing is also instructive because both Mr. Obama and GE symbolize a major reason the U.S. has become less competitive—the misallocation of resources.
Step back for a minute from the day to day policy fights and consider how an economy can grow faster. One way is to get people to work harder or longer. The government can contribute here with policies that reward work and investment, such as lower taxes.
A second route to faster growth is innovation, which means inventions or new processes that increase productivity. Government can help with money for basic research, but private investment, human ingenuity and luck are the main drivers.
The third way is through the more efficient use of capital, both human and monetary. These resources are scarce in any economy, and growth will be fastest if they are allowed to find their highest return. If resources are allocated to less productive uses or create asset bubbles due to bad policy, then overall growth will be slower than it should be.
In our view, this third point has been the largest but least appreciated problem in the U.S. economy in recent years. First the Federal Reserve’s subsidy for credit and other policies pushed resources into the financial industry, and especially into real estate. When that bubble burst, triggering the 2008 financial panic and recession, the U.S. responded over two years with a huge expansion of the federal government.
Both periods were marked by the misallocation of trillions of dollars into wasted investments. One reason the current recovery has been so lackluster is that it takes time for an economy to retool from these mistakes. Money that went to build now-empty condos on the Vegas Strip—or to government transfer payments—can’t be reclaimed to rebuild American manufacturing and technology.
No company illustrates this great misallocation better than the General Electric Co. For decades it was a symbol of U.S. manufacturing and export prowess, building jet engines, gas turbines, consumer appliances and more.
Yet during the bubble years, its fastest growing and often most profitable subsidiary became GE Capital. In some years, GE derived nearly half its total profits from the finance business. This contributed greatly to profits and made former CEO Jack Welch a shareholder hero before he retired in 2001.
Mr. Immelt inherited the time bomb that was GE Capital and it is probably too much to have expected him to defuse it before the panic hit. Most other finance CEOs and everyone in government also misjudged the mania. Yet without federal loan guarantees for debt issuance, among other government aid during the crisis, GE Capital might well have taken the entire company down.
Along with Mr. Obama, Mr. Immelt is now preaching the virtues of U.S. manufacturing and innovation. A glance at the GE homepage invites readers to "watch the rebirth of rails," of all things. GE also wants to produce more in the U.S., even though its domestic employment fell by about 34,000 from 2000 to 2009. These are laudable intentions.
Less laudable is Mr. Immelt’s habit of inviting government to be his business partner and promoter. In his 2008 letter to shareholders, the CEO declared that the financial crisis and election of Mr. Obama meant that the U.S. economy had been fundamentally "reset."
His key line: "The interaction between government and business will change forever. In a reset economy, the government will be a regulator; and also an industry policy champion, a financier, and a key partner."
This is an invitation to the same kind of capital misallocation that led to the housing bubble. Mr. Immelt’s particular goal is to promote policies and subsidies that aid green energy, in which GE is deeply invested. But if wind turbines are a good business, they will find a market on their own. If wind power turns out to be an uncompetitive bust, then the government will have misallocated hundreds of billions more dollars that could have found more productive uses.
Which brings us to Mr. Obama and the government bubble. In last night’s State of the Union, Mr. Obama tried to reposition himself as a champion of business and reformer of government. His support for lower corporate tax rates was especially welcome. The test of his sincerity will come in his policy choices in the coming months.
Yet Tuesday night can’t erase the fact that in his first two years Mr. Obama has overseen an historic expansion of government. He has increased federal spending to as much as 25% of the economy from a modern average between 20% and 21%. In terms of allocating resources, this means that 4% of annual economic output was suddenly taken out of private hands and put under government control.
Government "investments"—Mr. Obama’s favorite word last night—are by definition made for political purposes, rather than for their highest potential return. They are allocated by politics rather than by prices. In our view, that 4% of GDP a year could have contributed far more to economic recovery had it stayed in private hands.
But even if you believe that such spending prevented a depression, it makes no economic sense to keep those resources under political sway now that the recovery is underway. Would you rather have Congress allocating that 4% of GDP, or millions of individuals deciding among Apple, Gilead Sciences, or the next great idea?
The path back to faster growth, more jobs and a more competitive U.S. economy does not travel through more political mediation. Nor does it lie in endlessly easy Fed policy in a misguided attempt to refloat the housing bubble or revive the financial boom. A better economy requires policies that reward work and innovation, while letting capital flow to the companies and individuals with the best ideas. They might even be GE’s.