Saturday, 15 March 2014
Investment and the deficit are entirely separate issues.
Martin Wolf is my favourite economics commentator and I agree with about 90% of what he says. But in yesterday’s Financial Times he said, “Thus fiscal policy should be oriented towards high-quality investment in both the public and private economies”.
The truth is that investment decisions (public or private) have very little to do with the question as to how much fiscal stimulus (i.e. deficit) is suitable. That is, there is only one criterion to apply to investment decisions: does the investment pay for itself? Of course the exact way in which “pays for itself” is calculated in the public and private sectors can be different. That is, in the private secor its normally just a case of seeing whether income from the investment covers the cost of funding it, while in the public sector, the benefits do not always come in the form of cash income. But that difference is unimportant: the basic principle (to repeat) in both sectors is that investments should pay for themselves.
The purpose of a budget deficit, in contrast, is completely different: it’s to bring sufficient stimulus to give us full employment. Thus a reasonable assumption that those making investment decisions could make is that if full employment does not exist at present, then the deficit will bring it about in a year or two. Ergo it would be not unreasonable for decisions on investment to be made on the “full employment” assumption.
Of course that full employment assumption might look a bit silly in view of the time it has taken to recover from the recent recession, but that “time” is down to the incompetent manner in which recovery was managed. Hopefully in future, recoveries will be swifter.
At any rate, if the above full employment assumption were adopted, then the actual size of the deficit or surplus would have no influence on investment decisions at all.
In contrast to Martin Wolf, Kenneth Rogoff set out the above confusion surrounding deficits and investment in even more brazen form. He claimed that “A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects.”
Well if an investment is “high return” it should be made ANYWAY – regardless of whether there’s a recession or not! And Kenneth Rogoff is a Harvard economics professor. It makes you weep.
Another point against tying investment to deficits in any way is that the size of deficits varies from year to year by far larger amounts than GDP. Indeed, deficits sometimes become surpluses. Thus if investment, or indeed any other specific type of spending is tied in any way to the deficit, that form of spending will gyrate from one year to the next. And it’s just not possible to turn investment spending on and off unless you want gross inefficiencies.