Labour Investment versus Tory Cuts
I’m bored of the public spending ‘debate’. There are two issues which have been entirely conflated. First, was the Government right to launch a fiscal stimulus rather than aim to minimise the deficit, a la Ireland, last year? I think most sensible commentators now accept that the Government was correct. Second, a what point should the stimulus be withdrawn? Here we can have a genuine debate. I stand with Krugman (and I’ve dubbed the ‘crazy people gang’) that next year is probably too early. It all depends on when the long awaited ‘recovery’ begins. Or at least it should, but Cameron now appears to be embracing an ideologically driven, economically illiterate position.
But I want to turn to bigger issues. A while back Hopi asked:
So surely the biggest question in politics should be “What should we do to grow”, rather than “How and what do we cut”? The general consensus seems to be that recovery will be anemic and tentative, no matter what the official projections are. So why do so few politicians appear to have a coherent argument about how we can do about changing that?
Obviously, I’d be positively enthralled by a social democratic argument about what the role of the state was in priming short to medium term growth.
Of course, it’s easy enough to boost short-run growth – just throw enough money around. Promoting long-run sustained growth is, however, much trickier. It might even be impossible. This paper concludes:
“Except for the decades around WWII, there is no evidence of country specific effects on long run growth rates…Growth rates are determined by international factors, and are insensitive to national policies, especially for small countries. This implies severe restrictions on the ability of most governments to increase national long run growth rates.”
He used the examples of France, Italy, Spain, Sweden, UK and the US to illustrate this point. Although late, in the comments, when asked about Japan and South Korea he noted:
Policy and institutions matter enormously for whether poor countries catch up with the rich or not. It’s just that once freeish markets and secureish property rights are in place, and a country is near the technological frontier, the ability of policy to increase long-run growth seems to diminish a lot.
China has a series of interconnected and mutually reinforcing policies.
The first is the economy’s high proportion of exports – crucial to its “opening” process. Every economist since Adam Smith has known that the division of labour is a decisive lever in raising the level of productivity, and division of labour in a modern economy is necessarily international. A high level of exports and imports is the way of participating in such a division of labour – as well as benefiting from advantages such as economies of scale.
Economic theory therefore confirms what economic practice already demonstrated. That the alternative to China’s open approach, that of inward-looking “import substitution” policies lead to inefficiency in capital use and low productivity.
Critics of China’s “export-led growth” confuse two ideas. The first is a high level of exports in GDP, rightly integral to China’s growth model, the second is a high trade surplus – not integral to China’s model, which appeared only after 2005, and is now disappearing rapidly.
Second is China’s high level of investment. Modern econometric research shows conclusively that, following division of labour, the largest element in economic growth is the growth of fixed investment. This applies not only to a developing economy such as China but also to developed economies. Dale Jorgenson, the world’s leading expert on productivity growth, notes that “investment in tangible assets is the most important source of economic growth in the G7 nations. The contribution of capital inputs exceeds that of total factor productivity for all countries for all periods.”
Criticisms of China’s high level of investment would be valid only if China used that investment inefficiently, and contrary to claims made without evidence, all studies on productivity show that China uses that investment with an efficiency rate from respectable to high (pdf).
Third, a decisive point showing China has a “socialist market economy” and not “market capitalism”, is its method of macro-economic regulation. (My emphasis).
The second point here – investment – is crucial. Investment in the UK economy has collapsed Taking the most recent ONS estimate:
Gross fixed capital formation fell by 4.5 per cent, following a fall of 7.5 per cent in 2009 Q1. There were sharp falls in business investment on machinery and equipment.
The level of gross fixed capital formation is now 15.2 per cent below the same quarter of 2008.
The 15.2% drop in investment is the single largest driver of the fall in GDP. What’s more this has more than a short run effect. As John notes the work of Dale Jorgenson (former head of Economics at Harvard) suggests that investment is the driver of long term growth.
So rather than talking about the deficit, shouldn’t we be talking about the level of investment? Given it’s the biggest contributor to the recession and arguably the driver of long term growth?
How though do we go about raising investment? Ultra low interest rates and quantitative easing alone haven’t achieved it (although they have probably prevented an even worse fall).
As John has noted, Keynes dealt with this very issue.
Keynes noted in the final chapter of his General Theory, in a point highly relevant to a situation where mass unemployment is again soaring, that “a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment”.
I’m not advocating a command economy, I’m not advocating nationalising the commanding heights of industry. I’m simply arguing for direct public intervention to raise investment levels. In the short run this will raise GDP and in the long run it raises trend growth. It’s not even thst radical – it’s just a Keynesian solution.
If we embark on this policy then we can truly fight on the grounds of ‘Labour Investment versus Tory Cuts’.