"Boost Private Investment to Boost the Economy"

Hal Varian:

Boost Private Investment to Boost the Economy, by Hal Varian, Commentary, WSJ: These days it seems like it is our patriotic duty to consume more. And if we don't choose to spend more money ourselves, the government will do it for us.

But wait a minute. Isn't it excessive spending that got us into this mess in the first place? ... Despite this apparent paradox, there is some logic to providing a dose of economic stimulus. ...

In the ... U.S. economy..., consumers ... sensibly ... want to consume less and save more. In an ideal world, an increase in savings would automatically lead to an increase in investment. ...

Unfortunately, savings are currently not getting translated into investment... The net result is that money is piling up in ultrasafe assets like Treasury bills, without being invested in ways that would build a more productive economy. ...

The Obama administration now wants to ... provide direct stimulus of demand. But which component: consumption, investment, government expenditures or exports?

Increasing exports would be great, but it's not going to happen. The rest of the world is having its own problems...

Direct stimulus of consumption is tricky. In this economic climate,... tax cuts would probably be saved, and rightly so... Rather than relying entirely on direct stimulus of consumption, it is better to put a floor under consumption by making sure that unemployment benefits and food stamps are adequately funded.

That brings us to government expenditure... The danger with this form of stimulus is twofold: First, it takes too long for the government spending to kick in, and second, spending may easily focus on pork-barrel projects that have little inherent value.

There are worthwhile public infrastructure projects; the trick is to find them and fund them promptly. One possible plan is to set up an independent commission to prioritize public investment projects, and then subject the plan to a single up-or-down vote in Congress.

One further warning about government stimulus: It makes little sense for the federal government to spend more if the states are forced to spend less. A significant part of the ... spending should be transfers to the ... state and local level.

That brings us to private investment, which hasn't been getting nearly as much attention as it deserves. This is unfortunate, since private investment is what makes possible future increases in production and consumption. Investment tax credits or other subsidies for private-sector investment are not as politically appealing as tax cuts for consumers or increases in government expenditure. But if private investment doesn't increase, where will the extra consumption come from in the future?

Ultimately, we want to end up with a significantly higher savings rate in the U.S. than we have seen recently. That means some other component of demand must increase to compensate for the reduced consumption. And the most attractive candidate by far is private investment.

To the extent that it's possible to stimulate private investment in a timely fashion through tax changes, and to the extent that doing so does not displace public goods and services with higher social value either now or in the future, we should do so. But I wouldn't want to rely on tax changes intended to induce higher levels of private investment as the main thrust of an economic recovery program, and the other ideas above such as enhancing unemployment benefits and food stamps, increasing government spending, and giving aid to state and local government are, perhaps, getting more attention right now for good reason. In the long-run, a higher level of both saving and investment is a worthy goal, but in the short-run the first priority is stabilizing the economy, and tax inducements may not generate anywhere near enough new investment (or consumption) to turn the economy around.

Update: David Altig weighs in on the question of whether tax changes can stimulate private investment in a recession:

Will tax stimulus stimulate investment?, macroblog: ...This graph provides some interesting perspective... Relative to net worth (of nonfarm nonfinancial corporate businesses), private fixed investment has been in consistent decline since the second quarter of 2006. (The level of fixed investment has declined in each quarter, save one.) In fact, the investment/net worth ratio is currently at a postwar low.

Why? A couple of hypotheses come to mind. (1) Firms are extremely pessimistic about the outlook and see relatively few worthwhile projects in which to commit funds. (2) Credit markets are so impaired that the net worth of firms—a critical variable in mainstream models of the so-called “credit channel” of monetary policy—is supporting increasingly smaller levels of lending. (3) Nonfinancial firms, like financial firms, are deleveraging and hence not expanding.

Of course, even if one of these hypotheses is true, it need not be the case that marginal dollars sent in the direction of businesses will go uninvested. But it makes you wonder.