The case for government investment

Few would dispute the case that carefully chosen investment projects funded or at least promoted by the state are essential to sustained economic development. In particular, roads, railways and other infrastructure need replacement or maintenance over time, and these help to support economic growth by the private sector: they are the lifeblood of the economy. Over an even longer time horizon, spending on education which improves standards will also support growth and productivity. It is therefore depressing when, faced with an apparent need for public spending cuts, governments will often take the axe to public investment, which may be, politically, relatively easy, but economically illiterate. Both the plans of the last UK Labour government in its final days, and the actions of the current UK coalition government sacrificed public investment spending in order to reduce the deficit.

If public investment helps to support economic growth in the longer term, then it will generate a return in the form of increased tax revenue. There is no doubt that some public investment projects do not generate a return and are therefore wasteful, so decisions on spending should not be taken lightly, but many projects do have a positive impact on the economy. Successful projects can generate what are called positive externalities or spillovers for the economy or wider benefits for those who did not pay for the project. A new or improved public transport network between towns or cities where they did not otherwise exist could create new opportunities for private businesses to invest, generating new output, employment and incomes. In this way, public investment can ‘crowd in’ private investment.

In the short-term, public investment can create new flows of spending as well as new jobs, and may thus boost growth for a limited period of time. On the other hand, the way that public investment is funded can determine its impact. If it is funded by higher taxes, then the net impact on spending can be fairly neutral for the economy as a whole. If the taxes are levied on what are considered undesirable activities, then the net impact may positive, although this would be a matter of judgement. If the spending is funded by government borrowing and the economy is at a reasonably high level of capacity and employment, and interest rates rise as a consequence, the public spending could potentially crowd out private investment which would be competing for the borrowed funds. If there is plenty of spare capacity in the economy and interest rates are at what is called the ‘zero lower bound‘ as they are at present in many economies, then the increased borrowing need not crowd out private activity and can even crowd in such activity as described above.

Economists in the Marxist tradition, such as Michael Roberts, that what matters for the success or otherwise of public investment is how it affects the rate of profit. The latter is held to be the key determinant of private sector investment, which drives economic growth. If higher taxes or interest rates end up reducing the rate of profit, then the impact on growth will apparently be negative. However, I would suggest that no-one denies the need for public investment in particular areas of the economy, so if such investment takes place when interest rates are at the zero lower bound and is funded by borrowing, they may not be competing with private borrowing and could still boost growth in the short run and the longer run too, as private sector profits are crowded in. Even if the public investment is funded completely through higher taxes to avoid any rise in interest rates in a more buoyant economy, the rate of profit may fall in the short-term, but as the return on the particular project is generated in the medium to longer run, private profits could well rise back to a higher level over time.

Thus in a capitalist economy there will remain the need for government investment in infrastructure and other projects which generate a positive return over time. Particular publicly funded projects remain vital to economic prosperity so they would be essential at some point; even if they caused a temporary fall in the rate of profit, they could well contribute to its rise over a longer period.

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