It’s the Investment, Stupid

Dr. Steven Horwitz

Steven Horwitz: Posted at The Coordination Problem

Here is the most important blog post you will read all week, and it comes from the indispensible Bob Higgs. Bob points out that all the talk about “stimulating consumption” is beside the point because consumption spending is not the problem! Real personal consumption spending is now above its pre-recession peak. And Lord knows government spending isn’t the issue either. Anyone who’s taken intermediate macro knows what’s coming next: if GDP is lagging, and it’s neither C nor G that’s the problem, it’s a pretty good bet that it’s investment. Consistent with the emphsasis on regime uncertainty that has become Bob’s hallmark (and something I’ve tried to empahsize in other posts here), investment is indeed the problem (emphasis mine):

The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase, but because the true driver of economic growth—private investment—remains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its pre-recession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the ”capital consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

The key variable is net private domestic fixed investment—the investment that builds the productive private capital stock. Quarterly data through this year are not currently available at the BEA website, but the annual data show that an index of its real amount peaked in 2006, fell substantially in each of the following three years, and recovered only slightly in 2010, when the index showed net private domestic fixed investment was running about 78 percent below its level in 2005 and 2006. Here is the true reason for the recession’s persistence.

Private investors, despite the full recovery of real consumer spending and the increase of real government spending for final goods and services, remain apprehensive about the future of new investments, especially new long-term investments.

It really is that simple folks. There’s no better sign of the implicit acceptance of the Keynesian world view than the emphasis in the political realm and the popular press on the centrality of consumption (and jobs, for that matter) as a sign of economic health. It’s not. From at least J. B. Say onward, we’ve known that production is the source of demand, and that you have to produce value before it can be consumed. Austrians have long emphasized the importance of capital investment for economic growth. In fact, the contrast between consumption and capital is a good proxy for the contrast between Keynesians and Austrians. Austrians have also pointed out that the necessary investment will only take place in an economy characterized by respect for private property, the rule of law, and sound money. Right now, we don’t seem to have any of those three in the sufficient amount, and the results are just what Bob argues in this post.

You want recovery? Forget consumption. Ask yourself what sorts of policy changes would make entrepreneurs and investors feel like they know what to expect over the medium and long run and convince them that they will be able to keep the fruits of their labor and investments. Hint: the president’s jobs plan ain’t it.

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