The Road to Full Investment

A specter is haunting the treasuries and central banks of the West – the specter of secular stagnation. What if there is no sustainable recovery from the economic slump of 2008-2013? What if the sources of economic growth have dried up – not temporarily, but permanently?

The new pessimism comes not from Marxists, who have always looked for telltale signs of capitalism’s collapse, but from the heart of the policymaking establishment: Larry Summers, former US President Bill Clinton’s Secretary of the Treasury, and chief economist of almost everything at one time or another.

Summers’s argument, in a nutshell, is that if the expected profitability of investment is falling, interest rates need to fall to the same extent. But interest rates cannot fall below zero (in fact, they may be stuck above zero if there is a strong desire to build up cash balances). This could result in profit expectations falling below the cost of borrowing.

Most people agree that this could happen at the depth of a slump. It was to avert this possibility that central banks began pumping money into the economy after 2008. The novelty of Summers’s argument is the claim that “secular stagnation” began 15-20 years before the crash.

True enough, interest rates were falling, though not as fast as the fall in expected profit on new investment. So, even in the so-called boom years, most Western economies were kept afloat not by new investment, but by asset bubbles based on increasingly unsustainable leverage.

The generalized version of this proposition is that secular stagnation – the persistent underuse of potential resources – is the fate of all economies that rely on private investment to fill the gap between income and consumption. As capital becomes more abundant, the expected return on new investment, allowing for risk, falls toward zero.

But this does not mean that all investment should come to an end. If the risk can be eliminated, the investment engine can be kept going, at least temporarily.

This is where public investment comes in. Certain classes of investment may not earn the risk-adjusted returns that private investors demand. But, provided that the returns are positive, such investments are still worth making. Given near-zero interest rates and idle workers, it is time for the state to undertake the rebuilding of infrastructure.

Those who know their history will recognize that Summers is reviving an argument advanced by the American economist Alvin Hansen in 1938. Owing to a slowdown in population growth, and thus lower “demand for capital,” the world, Hansen claimed, faced a problem of “secular, or structural, unemployment…in the decades before us.”

The prolonged boom that followed World War II falsified Hansen’s projection. But his argument was not foolish; it was the assumptions underlying it that turned out to be wrong. Hansen did not anticipate the war’s huge capital-consuming effect, and that of many smaller wars, plus the long Cold War, in keeping capital scarce. In the United States, military spending averaged 10% of GDP in the 1950’s and 1960’s.

Population growth was boosted by a war-induced baby boom and mass immigration into the US and Western Europe. New export markets and private investment opportunities opened up in developing countries. Most Western governments pursued large-scale civilian investment programs: think of the US interstate highway system built under President Dwight D. Eisenhower in the 1950’s.

This mixture of stimulating events and policies enabled Western economies to maintain high investment ratios in the post-WWII years. But it is possible to argue that all of this merely postponed the day when the expected rate of return to capital would fall below the minimum rate of interest acceptable to savers, which would happen as capital became more abundant relative to population.

Hansen thought that new inventions would require less capital than in the past. This has now come to pass in what the MIT economists Erik Brynjolfsson and Andrew McAfee call The Second Machine Age. A company like Kodak needed and built vastly more infrastructure than its digital successors Instagram and Facebook – and (of course) employed many more workers. The inventions of the future may well consume even less capital (and labor).

What follows from this? The human race has proved very successful in the past at keeping capital scarce – mainly by engaging in destructive wars. One cannot exclude recourse to this solution in the future. Apart from this, it is surely premature to believe that the West has run out of investment opportunities. Some new inventions, like self-driving car systems, will require heavy capital investment in new kinds of roads. And one can think of many others. It is probable, though, that most of the new investment will have to be carried out with state subsidies.

But beyond this, one should view secular stagnation as an opportunity rather than a threat. The classical economists of the nineteenth century looked forward to what they called a “stationary state,” when, in the words of John Stuart Mill, the life of “struggling to get on…trampling, crushing, elbowing, and treading on each other’s heels” would no longer be needed.

If a point of true “full investment” – that is, a situation when the supply of capital increased to the point at which it would yield no net return above its replacement cost – were ever reached, it would signify that the human race had solved its economic problem. The challenge then would be to convert capital abundance into more leisure and balanced consumption.

Should that happen, we would be at the threshold of a new world – some would say a heaven on earth. We can be tolerably certain of one thing: our leaders will do their best to make sure we never get there.