Collective Conscious

Watch­ing a fairly vicious back-​​and-​​forth (start­ing here and end­ing here), I’ve been inspired to think a bit harder about stim­u­lus tar­get­ing as it relates to growth expec­ta­tions and recession-​​fighting. The more I do, the more I am con­vinced that Keynes, in his orig­i­nal form, was right.

Last week I took pains to remind Ed Mor­ris­sey that a pro­gram of tax cuts or pur­chase sub­si­dies, even if it comes from a Demo­c­ra­tic pres­i­dent, is not a Key­ne­sian pro­gram. In fact the dis­tinc­tion goes even fur­ther. Gov­ern­ment pur­chas­ing of con­sump­tion goods also does not count as proper Key­ne­sian stim­u­lus. Keynes him­self only advo­cated gov­ern­ment invest­ment pro­grams as an effec­tive inter­ven­tion to end a gen­eral reces­sion. His rec­om­men­da­tion was later “adapted” by a US pol­icy adviser (as detailed in Peter Clarke’s won­der­ful book on Keynes) to be bet­ter received by US sen­si­bil­i­ties which pre­ferred gov­ern­ment con­sump­tion over invest­ment. The record has never really been set straight.

So why invest­ment? Using the Econ 101 model you might think that con­sump­tion spend­ing and invest­ment spend­ing are inter­change­able when deter­min­ing GDP. You’d be right, but only in a short-​​run, single-​​period, super-​​simplified sit­u­a­tion. Gov­ern­ment injec­tion through con­sump­tion and invest­ment share one impor­tant prop­erty, in any case: every dol­lar spent will even­tu­ally wind up in someone’s sav­ings. But the key dif­fer­ence is the effect of the gov­ern­ment action on future behav­ior, since the point is after all to get eco­nomic activ­ity up to the point where you don’t need gov­ern­ment stim­u­lus anymore.

Con­sump­tion spend­ing sim­ply doesn’t do that. You can’t “prime the pump” of con­sump­tion over the long run sim­ply by spend­ing more now, because con­sump­tion is entirely depen­dent on income. The his­tor­i­cal sav­ings rate is rel­a­tively slow to change, and also rel­a­tively low: Amer­i­cans have never saved more that 10% of their incomes, and in recent years no more than 1 or 2%. So get­ting peo­ple to spend more of what they earn is futile: you have to actu­ally make them earn more, per­sis­tently, and only repeated gov­ern­ment cash injec­tions could pro­vide that ongo­ing sup­port. That’s unsustainable.

At the other extreme, as Mark Thoma sug­gests, this could be a “bal­ance sheet reces­sion” in which house­holds use addi­tional mar­ginal income to off­set past debts. This behav­ior would take mar­ginal sav­ing to near 100%, mean­ing that a cash injec­tion wouldn’t get very far in stim­u­lat­ing the econ­omy by the mul­ti­plier process at all anyway.

So we turn to invest­ment. Why does the “pump-​​priming” process work there? The answer lies again in that sav­ings rate, but also in finance. Whereas con­sumers are fac­ing drawn-​​down home equity and maxed-​​out credit cards, busi­nesses can get access to new lines of credit from banks and, indi­rectly, from the cen­tral gov­ern­ment through those banks. The trou­ble is con­fi­dence: if busi­nesses and/​or banks don’t expect the econ­omy to turn up, they won’t make those new invest­ments and loans. This turns out to be self-​​fulfilling, because it’s exactly those projects which will cause the econ­omy to perk up.

Gov­ern­ment inter­ven­tion, accord­ing to Keynes’ the­ory, should be designed to address this pol­icy. Famously, he sug­gested that even bury­ing money in aban­doned coal mines would perk up invest­ment — and it would! The promise of money would cause com­pa­nies to invest in great deals of equip­ment and man­power to dig it up, and shovel-​​factories would then invest in more shovel-​​production, and steel-​​smelters would invest in more ore extrac­tion, and so on.

In fact, though, we are smart enough to do bet­ter. We can have the gov­ern­ment invest in basic biotech­no­log­i­cal research that makes phar­ma­ceu­ti­cals more prof­itable in the future. We can have the gov­ern­ment invest in broad­band inter­net access to make peo­ple every­where more pro­duc­tive. We can have the gov­ern­ment invest in stu­dent loans to ensure a brighter, better-​​educated crop of entre­pre­neurs in the future. We can invest in high-​​speed rail to lower the cost of busi­ness trips. The list goes on and on. But the impor­tant thing is that we invest in some­thing, and busi­ness will perk itself back up in response.

(Photo: skip­pyjon)