Wednesday, October 26, 2011

A different perspective

Rutgers history professor James Livingston argues for more consumer spending and less business investment as a "key to economic recovery" that is also "necessary for balanced growth in the future." In a broad sense, he's absolutely right that consumption is important for growth. It's about two-thirds of income, after all, so by definition it is important. 

But the supporting facts he cites are either wrong or misleading. He chooses to compare growth in gross domestic product to shares of net business investment in GDP. In fact, the share of gross business investment in GDP has averaged a fairly constant 15% in the postwar period, expanding during booms and falling during recessions.

It's also misleading to say that "in 2000, most investment was either from government spending (out of tax revenues) or 'residential investment,' which means consumer spending on housing, rather than business expenditure on plants, equipment and labor." In that year, residential investment was about 5% of GDP, while private nonresidential (business) investment was more than twice that share, at 12%. By comparison, in 1997, the closest year with available data in the NIPA, government fixed investment was about 3% of GDP.

A basic tenet we teach undergraduates and Ph.D. students alike is that saving is important for long-term growth, whether it takes the form of fixed capital formation or replacement or investment in human capital or innovation. Consumption is the end these means facilitate.