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Real Investment Instead of Short-Term Stimulus

May 24, 2012 by Ike Brannon

Much attention was given to the recent G-8 Summit’s closing communiqué, which pledged a renewed emphasis on “economic growth.” However, few bothered to note the intentional ambiguity in the statement, or the lengths that were taken by the major industrialized nations to avoid spelling out how growth should be achieved. By intentionally conflating short-term demand-side stimulus with the supply-side policy changes necessary to achieve stronger and more durable long-run economic growth, the heads of state lost a major opportunity to explicitly chart a sensible economic course. The debate over how a country should extricate itself from a fiscal hole has played out many times before. Today, Keynesian economists such as Paul Krugman advocate a looser monetary policy and more government “investment” in things like infrastructure to jump start the economy. Larry Summers and Brad Delong even argue that carefully crafted stimulus programs will cost the government nothing, because the increased growth will result in enough tax revenues to pay for them. The problem with such sentiments — besides the inanity that spending programs pay for themselves — is that it is beyond the government’s ability to “carefully craft” a sensible spending plan. Our transportation dollars are not allocated by a team of impartial technocrats. On the contrary, Congress would have to decide how much to spend and how to spend it; tasks that take months or years and rarely result in an efficient allocation of scarce resources. The second problem is that stimulating aggregate demand does not really constitute a “growth” policy. By definition and design it can only work in the short-run by encouraging firms to expand output and hire more workers. Even if the government were able to spend effectually, the productive capacity of our economy serves as a natural limit on how much such spending could boost growth. And most government spending does little to expand that capacity. However, the G-8’s explicit call for reforms that improve productivity — which would improve our economy’s capacity to produce goods and services — are worth exploring. Few journalists have bothered to do so yet, maybe because it’s a notion that the countries themselves haven’t been paying much attention to of late. Spending more money is easy to sell to constituents, but reforming the tax code or taking other steps to encourage private investment is a bit more difficult to explain to the average voter. A tax code that incentivizes investment ultimately results in more investment. This makes workers more productive and ultimately pushes up wages and the standard of living. It’s that last step in the logic chain where people can get lost, despite a plethora of evidence supporting it — including a developing consensus among tax economists that the workers bear most of the burden of the corporate income tax through lower wages. In the 1970s, U.S. governments, presided over by both political parties, focused on stimulating aggregate demand to generate economic growth. When this failed, it was out of desperation that the Congress turned to deregulating key sectors of the economy in an attempt to get something going and be reelected. Ultimately, the gains didn’t come soon enough and the country elected Ronald Reagan along with a Republican Senate. Demand-side stimulus then took a back seat to supply-side policies focused on improving long-run economic growth. Let’s hope a few politicians in the G-8 react likewise, beginning with our own.


Author

Ike Brannon
Ike Brannon

Ike Brannon served as an Economic Growth Fellow of the George W. Bush Institute from 2012 to 2015. He has a Ph.D. in economics from Indiana University and a B.A. in math, Spanish, and economics from Augustana College. View his full bio

Full Bio