Friday, July 10, 2015

Keynes, Secular Stagnation, and Investment Shortfalls

The buzzword "secular stagnation" has come to refer to all sorts of arguments about why economic growth has been slow, ranging from concerns about a lack of technological opportunities, a lack of investment in education and infrastructure, the aftermath of the financial crisis when it becomes hard for firms to get the capital they need to invest, and when a lack of aggregate demand in an economy means that business don't feel that they have an incentive to invest.

But the original meaning of the term as put forward in 1938, as I discussed in "Secular Stagnation: Back to Alvin Hansen" (December 12, 2013), was a speech in which  Alvin Hansen expressed a concern that in the depressed economy of his time, with lower birthrates and a lack of discoveries of new resources and territories, the push of new inventions would not be enough to keep investment levels high and the economy growing. When Larry Summers resurrected the "secular stagnation" term in a series of speeches in 2013 and 2014 (for example, here), he emphasized the lack of incentives for investment, and offered as a possible policy solution a considerable expansion in infrastructure investment. I've written previously about some of the potential explanations for "Sluggish U.S. Investment" (June 27, 2014).

For several decades after Alvin Hansen's 1938 speech, there was considerable concern among economists that it might be perpetually difficult for an economy to reach full employment, because of a tendency for demand to be insufficient. There was often a policy recommendation that the government might need to bolster investment in some way. Here are some thoughts that John Maynard Keynes had related to this subject in a little essay on "The Long-Term Problem of Full Employment," dated May 25, 1943. It's available in volume 27 of The Collected Writings of John Maynard Keynes edited by Donald Moggridge, pp. 320-325.

Keynes begins by stating: "It seems to be agreed to-day that the maintenance of a satisfactory level of employment depends on keeping total expenditure (consumption plus investment) at the optimum figure ... The problem of maintaining full employment is, therefore, the problem of ensuring that the scale of investment should be equal to the saving which may be expected to emerge ...."

Writing in 1943, Keynes then predicted "three phases" that would appear after the end of World War II. In the first phase after the war, there would be an investment boom, which in his view the government should act to tamp down:
"It is, however, safe to say that in the earliest years investment urgently necessary will be in excess of the indicated level of savings. ... In the first phase, however, equilibrium will have to be brought about by limiting on one hand the volume of investment by suitable controls, and on the other hand the volume of consumption by rationing and the like."
In the second phase, after a period which "might last five years," then those controls could be ended. At that point, Keynes' prescription was that government would influence a large share of investment and steer it to the right level so that it would stabilize the economy. He wrote:
"If two-thirds or three-quarters of total investment is carried out or can be influenced by public or semi-public bodies, a long-term programme of a stable character should be capable of reducinjg the potential range of fluctuation to much narrower limits than formerly, when a smaller volume of investment was under public control and when even this part tended to follow, rather than correct, fluctuations of investment in the strictly private sector of the economy."
Keynes predicts that the second state "might ... last another five or ten years." The third section is then what Keynes calls the "golden age." In this stage, not as much investment will be desirable or needed. The goal will only be to have enough investment to replace capital equipment as it depreciates. Rather than pumping up investment, the goal of government should be to reduce savings and encourage people to spend on leisure activities. Keynes writes:
"It becomes necessary to encourage wise consumption and discourage saving,--and to absorb some part of the unwanted surplus by increased leisure, more holidays (which are a wonderfully good way of getting rid of money) and shorter hours. ... The object will be slowly to change social practices and habits to reduce the indicated level of saving. Eventually depreciation funds should be almost sufficient to provide all the gross investment that is required." 
In this third stage, if there is a need for countercyclical fiscal policy, Keynes suggests that it might be carried out by "varying social security contributions according to the state of employment."

From a modern perspective, Keynes' arguments are remarkable in a number of ways. For example, they presume a very high level of activist macroeconomic policy. When investment is high, government should tamp it down. When investment is medium, government should control "two-thirds or three-quarters" of it to limit economic fluctuations." When investment inevitably becomes low, then to avoid the problem of secular stagnation, government will need to boost consumption and leisure.

I suppose that one can theoretically imagine a situation in which all these government controls are general in nature--that is, government wouldn't be favoring or disfavoring specific industries or sectors, and would not be interfering in specific investment or consumption decisions,  Keynes approvingly quotes another writer on the merits of how the state might "fill the vacant  post of entrepreneur-in-chief, while not interfering with the ownership or management of particular businesses, or rather only doing so on the merits of the case and not at the behests of dogma." Of course, in the real world of politics, this kind of beneficent neutral interventionism that operates "n the merits of the case and not at the behests of dogma" seems rather unlikely.

Finally, the "golden age" imagined by Keynes sounds like a time of economic stasis, what old-time 19th century economists used to call the "stationary state." The notion that the leading economies of the world were about to reach that stationary state back in the 1950s or 1960s doesn't seem like one of Keynes's best predictions. But the notion that such a view was widespread perhaps helps to explain why Great Britain made a series of business and policy decisions at about this time that helped bring about slower growth for a few decades.

I have little confidence in the kind of activist macroeconomic policy and government control over investment and consumption that Keynes describes here, and no confidence at all that the high income economies of the world are near a stationary state. However, the problem that when the economy is already slow, firms have little incentive to invest, and so the economy stays slow for longer, seems like a real one to me. While I have no particular disagreement with the need for more  investment in fixing roads and bridges, the real prosperity of the future isn't going to depend mainly on fewer potholes and more multi-lane roads. I fear that we settle on fixing roads and bridges as a motherhood-and-apple-pie solution for investment shortfalls because we have a hard time agreeing on how to encourage or even to allow other kinds of investment, like pipelines for oil and gas, new intercity rail tracks, or more resilient grids for electricity and communications. We also seem to have a hard time boosting research and development, or raising the skills of workers, which provides the ideas and the employees for new business investment to take place. We seem to have a hard time talking about whether its possible to shape all the rules and regulations and laws that affect business investment and expansion in a way that still accomplishes desired public goals, but with a reduced disincentive for firms to invest and expand.