Economic development and public investment – Economic Reform Australia

Economic development and public investment – Felipe Rezende

You may check James K. Galbraith’s interesting conference paper “The Macroeconomic Considerations of a Public Investment Strategy” [1]. An important point is that “contrary to popular myth, U.S. economic development has never been solely the result of private investment.” He goes on to demystify the belief that government deficits crowd out private investment and that the U.S. federal government relies on foreigners to finance its spending.

Interest rates

“Critics assert that efforts to expand the scope of the public sector will drive up interest rates and crowd out private business investment. The accusation is particularly likely to be heard when a proposal explicitly foresees the use of the credit market, deficits, and public debt to finance the expansion.

“Are these fears justified? There is a two-part answer to this question, the first related to economic theory, and the second to the specific conditions facing the United States in the world credit markets. The “crowding out” theory is based on a commonly held misconception of the nature of savings in our economy, namely the idea that savings are a “pool,” fixed in size, from which the public and private sectors alike draw to finance their desired rates of spending.

“No such pool exists. Rather, what we measure as savings is created after the fact, by the spending decisions of governments and private businesses. These decisions create income; the difference between income and consumption (the latter strongly established by habit), is savings…We can conclude, first, that there is no direct connection between federal budget deficits or surpluses and long-term interest rates.”

Financing abroad and the dollar

“The deficit in the external accounts is the accounting counterpart – the exact equal – of the sum of public and private sector deficits in the domestic economy.

“This phenomenon is often referred to as “borrowing from foreigners to finance current consumption,” but again the shorthand is misleading.

When an American purchases a Japanese car, credit is created and extended by an American bank.

“Rather, a bank loan made in the United States has created a dollar asset, which subsequently has been purchased by an institution (the Bank of Japan) that has no immediate use for it and merely chooses to store it in a liquid, interest-bearing form.”

Source: New Economic Perspectives http://neweconomicperspectives.org/2009/06/economic-growth-and-public-investment.html

Reference: Prof J.K. Galbraith – http://www.newamerica.net/files/NAF_PublivInvest_color.pdf