Guest editorial - Entering the zone, an inflationless expansion

By Larry Kudlow

Economics editor of National Review Online

Co-host of CNBC's Kudlow & Cramer

If we knew gross domestic product would run at 4 percent, industrial supply at record levels, basic inflation at less than 1 percent, real disposable income at 3.5 percent, gold around $400 and the 10-year Treasury bond just above 4 percent -- and we knew these performance results would last for many years -- we would be very happy indeed.

Why then is everyone suggesting that 4 percent GDP -- the just-released mark for last year's fourth quarter -- represents an economic slowdown? It's all blather.

Not only is such alarmism uncalled for, but the basic components inside the GDP report are very favorable. The U.S. economy, spurred by a significantly lower tax bite on investment and financed by a moderately easy Fed, is now generating more investment and production than consumption. In other words, we're investing and producing more than we consume. Supply is growing faster than demand.

As a result, the excess supply (stated in growth terms) has actually reduced the core inflation rate even as overall economic growth is registering its best gain in many years. GDP for the second-half of 2003 was a stellar 6 percent, and the core price index for consumer spending eased to 0.7 percent in fourth quarter, compared to 1 percent in the third. We're in an inflationless expansion.

Supply-siders have long argued that growth solves inflation. The availability of more goods absorbs excess money -- especially when growth is well balanced on the shoulders of tax incentives that spur the investment side of the economy. Moreover, the rise in capital formation is contributing to outsized productivity and profit gains. This, in turn, will soon lead to rapid job creation.

Liberal economists seem not to recognize that capital is labor's best friend. Without new capital formation to spark profitable new businesses -- which create new jobs and a more efficient workforce (equipped with the latest technologies) -- labor prospects would be gloomy, not upbeat.

Critics in the media and on the campaign trail are skipping a beat as well when they say we're in a jobless recovery. They of course ignore the new culture of small-business self-employment that, in the Labor Department's house-to-house survey, registered 2 million new jobs last year (compared with a loss of 70,000 in big-business payrolls). But the addition of 2 million workers, in large part generated by higher take-home-pay rewards from lower individual tax rates, won't be counted in the government's payroll survey for 18 to 24 months.

One reason corporations have been slow to hire is that the non-entrepreneurial sector of the economy is only just now beginning to flower. Excluding government spending, real private-sector GDP has expanded at a 5.3 percent annual rate since the Bush tax cuts became law last spring. In the prior six quarters, private-sector growth averaged only 2.5 percent.

As a rule, the expansion of corporate payroll jobs requires that private GDP grow faster than output-per-hour productivity. Since the end of 1995, output-per-hour has increased at a 3.2 percent annual rate. So the 3 percent private-GDP gain in 2002 and early 2003 was insufficient to create new jobs. But the better than 5 percent growth since then has exceeded the trend-rate of productivity. Hence, we are now entering the zone of new job creation -- right as the tax-cut-nurtured economy has shifted into high gear. Payroll jobs could rise by 2 million this year.

The significant pickup in U.S. exports abroad also attests to the country's renewed economic health. As the overly strong dollar has normalized, exports doubled to 19 percent in the fourth quarter compared to less than 9 percent in the third.

The heightened after-tax competitiveness of American business will continue to surprise everybody with record export volumes. As we produce more than we consume inside the U.S. economy, the excess production is being shipped abroad, spurring world economic growth.

Democrats may carp about short-run budget deficits, and the vast majority of media commentators are obsessed with these deficits, but the economy is healthy, the stock market is strong, trade flows are positive, and interest rates and inflation are at rock bottom. Let them carp and obsess.

Liberal Yale economist Ray Fair has perfected a model that predicts election outcomes. Recently, his model has been re-estimated by the well-respected Macroeconomic Advisors of St. Louis. Both models came within a few tenths of a percent of accurately predicting the popular vote in 2000. Taking into account today's strong economy, both predict a Bush victory with roughly 60 percent of the vote come November.

In electoral terms, it's the economy, not the budget deficit, that will decide November's presidential election. Bush's economy, and his re-election prospects, are in fine shape.