James Livingston, a Rutgers history professor, lambastes supply-side economics in a recent column in the New York Times. Similar to proponents of Modern Monetary Theory (MMT) who label government spending and debt as the fount of all money, Livingston goes one step further and names consumer and government spending and debt as the true drivers of all wealth creation. His view of the world leaves private investment entirely out of the picture, and calls this concept the best-kept secret of the last century, as follows:
Private investment — that is, using business profits to increase productivity and output — doesn’t actually drive economic growth. Consumer debt and government spending do. Private investment isn’t even necessary to promote growth.
No economist worth his salt would ever say that investment itself is not necessary for growth. If there's one "iron law" of economics, its that foregone consumption (savings) is the source of capital for future investment and growth. Livingston appears to be conceding this fact, but saying instead that its not the "what" that matters (investments happen), but who makes them. He goes on to support his contention as follows:
Between 1900 and 2000, real gross domestic product per capita (the output of goods and services per person) grew more than 600 percent. Meanwhile, net business investment declined 70 percent as a share of G.D.P. What’s more, in 1900 almost all investment came from the private sector — from companies, not from government — whereas in 2000, most investment was either from government spending...or “residential investment,” which means consumer spending on housing, rather than business expenditure on plants, equipment and labor. In other words, over the course of the last century, net business investment atrophied while G.D.P. per capita increased spectacularly. And the source of that growth? Increased consumer spending, coupled with and amplified by government outlays.
Let's deconstruct this as best we can. First he conflates correlation with causality by noting the diverging trends in real GDP and private investment. Real GDP did just fine, he says, while private investment was falling as a fraction of GDP, so private investment doesn't matter.
There's just one problem: Who's to say that private capital hasn't become much more efficient over the years, resulting in a bigger growth bang for each investment buck? Isn't this the very definition of improved productivity? Workers can become more productive; why can't capital? It can, and the best modern example of this phenomenon is Moore's Law. A dollar of investment in a microprocessor production line today yields computing power billions of times greater than the same dollar invested 60 years ago at the dawn of the semiconductor age. Farmers and physicians can see this basic truth as well. The exponential growth in crop yields and disease fighting power of biologic drugs are both products of more efficient capital. These trends are in fact the basic forces of the information age. Concentrated knowledge and technological expertise, focused on the big problems of the day, make our lives better. How can Livingston ignore this?
After denigrating this most obvious source of prosperity, he compounds the error by crediting the growth over the past hundred years to increases in general government spending and the housing stock. The problem here is that the vast majority of the dollar value of both these categories should be classified as consumption, rather than investment. Some might argue that a better-housed work force could be a catalyst for growth, but we've learned over the past decade that a McMansion in every pot (funded with funny money to boot) is a much greater drag than a driver of social well being. And yes, certain government "investments" do create long term assets (roads, dams, navy ships, university laboratories, NASA, etc.), but the great majority of public dollars go either to support consumption by those who politicians deem worthy, or Solyndra-like boondoggles.
To sum up, Livingston has it exactly backwards. False historical correlations notwithstanding, real wealth creation has very little to do with growth in consumer spending, debt or government expenditures. Government spending creates few real assets because, by definition, it consists mostly of simple transfer payments, with a not insignificant cut for bureaucrats. Real assets, on the other hand, those which produce reliable long-term streams of production and income, are the product of accumulated capital and focused application of that capital in order to satisfy customers, thereby producing a profit.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.