Sustaining economic growth and public vs private investment

Millen bridge London

Construction of the Millennium Bridge, London

What are the drivers of economic growth? Many economists would agree that investment is vital, as it adds to both demand as a form of spending, and supply as an increased capacity to produce output and raise productivity. Investment can come from either the private sector or the public sector. Since the 1990s, governments have also tried to get the private sector to finance major construction projects, and then pay for the use of them once the project is completed. This shifts public borrowing off the government’s balance sheet, while potentially raising subsequent spending. It remains controversial.

With global economic growth currently looking a little sluggish, there is plenty of debate among economists and policy-makers over what should be done, if anything. Interest rates in the rich world are at record lows, and public debt is quite high; there seems to be little scope to boost demand through monetary or fiscal policy should growth continue to slow. Should governments and central banks just roll over and leave it all to the private sector?

There is one clear argument for public investment: with interest rates at such a low level, the cost of government borrowing is negligible. Spending on infrastructure, from repairing roads to flood defences, would seem to be a no-brainer. Major projects such as high-speed railway in the UK, require more careful consideration of the potential costs and benefits to the economy.

Some economists argue that public borrowing tends to crowd out private investment through raising interest rates or taxes (if the government does not borrow to invest). These factors increase the cost of private economic activity, reducing some combination of wages or profits, and therefore potential consumption and investment. Keynes argued that this is only true at full employment, or in the absence of a potential surplus of labour. His detractors, who tend to have less faith in government intervention, and more in the private sector, may also argue, no matter what, that public spending is always less efficient than private spending, and will thus reduce overall welfare.

If the private sector would not have invested in the first place due to weak demand, as is currently the case in many economies, then public investment funded by either borrowing or higher taxes can raise the growth rate. A rise in corporation tax may simply reduce dividend payments or share buybacks; a higher consumption tax might reduce consumer spending; higher taxes on income may have a similar effect. If any of these changes reduce consumption in order to fund productive investment, growth can be raised. With weak private investment and spare capacity in the economy (supply exceeds demand), then public investment can ‘crowd in’ private activity by raising prospective returns to the private sector and encouraging it to invest itself. This is a potential win-win for the economy.

If public investment does crowd out private investment, then the effect on growth depends on the productivity of the former compared with the latter. As mentioned above, right wing economists tend to deny that public spending can ever be better than private spending, while many on the left adopt a more favourable view to state intervention. Economies with poor infrastructure offer a good case for increasing public investment and crowding-in effects are more likely to occur. Economies with full employment and little unused capacity as well as first-class infrastructure have less to worry about.

In economies with weak infrastructure, weak private investment, excess capacity in labour and product markets, and weak growth, the case for public investment is very strong. With the global economy slowing, policy-makers should keep this in mind.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s