The Case for Public Investment Led Growth
It strikes me that progressive economists should talk less about the need for immediate fiscal stimulus, and more about the case for an extended period of public investment led growth.
Of course, as we slide into recession, Canadian governments will likely shift from surpluses to deficits simply by not cutting spending as much as revenues fall in line with shrinking employment and GDP. They should, of course, not let deficit-phobia get in the way of running a cyclical deficit and should let the so-called automatic stabilizers operate (to the limited extent that they still exist on the spending side here in Canada after cuts to EI, and the end of 50/50 federal-provincial cost sharing of social assistance.)
The need to run a cyclical deficit is actually now the mainstream economics view, reflected in statements by bank economists, the IMF and the OECD, articles in the Economist etc. Even Flaherty has hinted broadly at his acceptance of this view, though I have not yet heard the Liberals or New Democrats strike even this timid note. Parts of the mainstream are even calling for modest fiscal stimulus, which could, in principle, come in the form of tax cuts or government spending.
By contrast, I think we need a large deficit financed public investment program to be maintained over several years.
The case for major investments to rebuild crumbling public infrastructure, to promote energy efficiency and a shift to new forms of energy, and to raise skills existed long before the immediate crisis. We need these investments for basic public good purposes, and also to raise business sector productivity. A properly conceived public investment program also has the potential to stimulate new industries.
We need a major medium-term public investment program because the old growth model has collapsed. It is simply inconceivable, even in a best case scenario, that Canada or the US – to whose fate we are inextricably linked – will soon return to growth based mainly on debt-financed household spending. Globally, the main growth dynamic will have to come from surplus countries , whose demand is for commodity and capital goods imports. That might provide some stimulus to Canadian exports, but the fact remains that household retrenchment in North America will remain with us for a long time due to the collapse of the housing bubble, the collapse of the equity bubble, the deleveraging of the financial system, and the shock and after shocks of the major and potentially self-feeding rise in unemployment which we are about to experience. I find it hard to believe that a slump in consumption can be offset by much higher net exports, or by an increase in private investment.
The recession we are just entering has its origins in the collapse of speculative housing and other bubbles, and a banking crisis. Typically such downturns last much longer than average. This is a profoundly different situation from the last two Canadian recessions of the early 1980s and early 1990s, which were in large part the product of tight monetary policy. The key risk today is of deflation, not inflation.
In a deflationary situation, especially one accompanied by a banking crisis, monetary policy has little purchase and needs to be accompanied by a fiscal stimulus. Once that point is accepted, attention has to shift to the most economically efficient form of stimulus. Work by Informetrica and other shows that there is much more bang for the buck from public investment (and even more for direct spending on public services) as opposed to personal income tax cuts (and business tax cuts have an almost trivial macro economic impact.) The impact on GDP of a given increase in government investment is 60% – 100% more than equivalent personal income tax cut since public investments are generally fairly labour intensive, have a low import content, and do not disappear into savings.
The lack of an inflation risk means that the Bank of Canada and other central banks can, already have and likely will again push interest rates down, perhaps to levels just above zero as has been the case in Japan for an extended period. This – combined with a newly found strong aversion to risk on the part of banks and investors – means that even a very ambitious public investment program could be easily financed at a very modest cost.
Investors have become so risk averse that they are unwilling to fiinance private investment, as indicated by huge spreads between government and corporate bond yields. If overall investment is to be maintained, there simply has to be a major shift from private to public investment.
The other major point to be made is that public investment in the context of a serious recession is self-financing to a non trivial degree. If it generates significantly higher GDP via the multiplier, the tax base rises and some costs are recouped through higher revenues.
Finally, for those who worry unduly about large deficits, we can and should allocate long term public investments which produce future returns to a separate capital account.
In sum, we should stop making defensive arguments in favour of modest deficits, and stake out ground for a large, medium term investment program.