Written by John Slater
Growth begins with investment. That’s what I learned as an undergraduate economics student in the 1960s, studying the economics of development. Since then my career has been focused on helping entrepreneurial businesses find the capital they need to grow. As a disciple of Milton Friedman, I became very concerned in the 1970s that excessive government borrowing would crowd out the private sector’s ability to fund the necessary investment needed to fuel future growth. This played out as the massive expenditures made to prosecute the Vietnam War and to fund the Great Society programs of the 1960s contributed to the capital shortfalls and rampant inflation of the 1970s, impeding business investment and ultimately culminating in the disastrous 1980-1982 financial crisis when short-term interest rates exceeded 20%.
The Volcker austerity and tax rate cuts of the Reagan era ultimately ushered in a period in which investment capital became abundant. Certainly Michael Milken’s invention of high-yield debt as a substitute for equity investment to fund business expansion played a big role. There were excesses, but these were quickly washed out and the 1990s witnessed a period of growth unparalleled in modern American history. Capital was abundant and has remained so for most of the intervening years, at least for large companies with access to the capital markets. Today the world suffers, not from a capital shortage, but from capital excess. Certainly there are misallocations and many small business owners would question my sanity for saying that capital is adequate, but that’s a topic for another day.
Without in any way minimizing the importance of entrepreneurship, which I have championed all my life, it seems clear that most of the periods of rapid economic progress in the United States have been associated with periods of governmental expenditures or subsidies for infrastructure investment. In the first half of the 19th century governmental support was critical for development of the canals and the roads west, which spurred great speculative land booms and led to development of the Western frontier. During the Civil War Lincoln’s investment in the railroads and telegraph system provided the infrastructure base for the explosive Industrial Revolution that followed. His successors continued with subsidies for the building of the Western railroads, which opened the West and spurred growth across the continent.
In the last century we saw the development of the Interstate Highway System provide the foundation for the automobile-based consumer culture in which we live today. In retrospect the 1950s and 1960s were incredibly prosperous times as a result. More recently governmental investments in digital network technologies (ARPANET) and the Human Genome Project spurred the creation of the modern digital communications infrastructure and the Internet as well as the biotech revolution.
Everyone agrees that there is a valid role for government. For Republicans it’s the military, homeland security, border defenses, etc. For the Democrats its education, research, social welfare, etc. There are even some expenditures, such as support for the National Parks, on which most of us could agree.
Neither party seems willing to consider any cuts to the massive transfer payments programs we now call entitlements. Those programs have become an uncontrolled monster eating away at the federal budget and there is no political will in either party to reduce the programs or to pay for them with other than borrowed money. While other aspects of government are shrinking, entitlements seem destined to continue their inexorable rise. Recently Steven Hansen highlighted this dilemma in an article on Global Economic Intersection, which includes the graph below.
In the current debate over the Sequester, both sides seem to be reveling in the impact of the cuts on the other party’s favored programs, while assuring us that the Republic will end if their programs are not restored. To date the important function of governmental investment as a spur for economic growth seems to be lost in the shuffle. With Medicare predicted to consume an ever-increasing share of GDP, it seems predestined that large deficits will continue and the debt will inexorably grow. In that scenario there seems to be little room for the type of bold governmental investment that has, in the past, acted as a spur to rapid economic growth.
Perhaps the main benefit of the Sequester debate is that the underlying issues are finally being discussed. On March 4 Charlie Rose hosted Joe Scarborough and Paul Krugman for a lively and intelligent discussion of the issues underlying the current austerity debate. Krugman, while giving lip service to the long-term dangers of excess debt accumulation, appeared to take the view that any spending is good while the economy is in a liquidity trap.
We hear similar sentiments from some of the Modern Monetary theorists. One only has to look at the history of the 2009 stimulus bill to know that this is patently false. As a country we threw away $700 billion with virtually nothing to show for it. At the time most thoughtful observers agreed that a major stimulus was needed, but that it should be invested primarily in infrastructure. Politics intervened and the money went to a grab bag of payoffs to the constituencies of both parties without any meaningful impact on national infrastructure investment.
Interestingly this morning (March 5) on Morning Joe, Jeffrey Sachs, generally thought of as a “liberal” economist, provided the clearest explanation I have heard as to how the national discussion has fallen into this trap. He pointed out that the model which economists generally refer to as the Keynesian model (and which most likely Keynes himself would have rejected as overly simplistic) only includes one variable for expenditures and that is gross domestic product. In this model it doesn’t matter what you spend money on. So long as there is liquidity trap governmental expenditures will create economic activity.
While government deficits have clearly helped keep the economy from the brink of total collapse, they have not spurred growth. When you look at the economy’s ability to employ our population, we suffered a dramatic collapse during the recession and we have seen virtually no rebound since.
Why does the developing world continue to prosper as the West is mired in recession/depression? The so-called Asian economic miracle is not a historical accident. Each Asian country that has enjoyed explosive growth, starting with Japan, then Korea and more recently China made a massive investment in their growth. Whether through thrift or coercion, each of those countries found a way to divert a massive share of its national income into investment for infrastructure and for the development of industry.
My training taught me to believe that investment always precedes growth. I would posit that the United States and in fact the entire world can be looked upon as an underdeveloped society as compared with the new world which the ongoing technological explosion should make possible in the 2020s and beyond. Those countries which find a way to build the infrastructure necessary for participation in that new world economy will prosper and those that do not will be left behind.
While certainly industry and private enterprise will continue to provide the energy needed to convert capital investment into economic activity, government must play a role in preparing our society for this future. Investment in education, new technologies and the rebuilding of outmoded urban infrastructures are clear examples of where this investment is needed.
I’m not arguing for an abandonment of the social safety net. That train left the station long ago. What I am arguing is that unless government becomes far smarter in the ways that it provides that safety net, focusing on investment in the future rather than purely on subsidy of the present, the Entitlement State will crowd out the ability of government to invest for the future. Without that investment, I do not believe we will make the transition that is required for our society, including the private sector, to continue as the leader in a rapidly changing world.
