Peter Cooper — Government Spending and Financially Sustainable Growth [wonkish]

Private and public exogenous expenditures have opposite impacts on the sectoral balances. The same rate of growth in income has different implications for the domestic private sector’s financial balance (saving minus investment or, equivalently, income minus private spending) depending on the composition of the demand driving that growth. An increase in private investment pushes the private sector toward deficit. Even though the investment boosts income, saving will not rise as much as investment because of leakage to taxes and imports. In contrast, government spending adds income and saving for a given level of investment. An implication is that growth driven by private expenditure that occurs without compensating growth in government spending pushes the private sector into deficit except to the extent that net exports counter the effect. 

A growth regime reliant on private sector deficits is likely to come unstuck sooner or later. It implies depletion of net financial wealth and a likelihood of growing private indebtedness. Since households and firms, unlike a currency-issuing government, are financially constrained, this process has financial limits. Recent history culminating in the global financial crisis reflects this. Eventually, households and firms are compelled by circumstances to restore balance sheets to more normal levels. For growth to be sustained without exacerbating the tendencies to financial fragility already inherent in the present economic system, demand, and government spending in particular, would have to grow in a way that is compatible with ongoing domestic private sector surpluses.

Needless to say, government spending growth of this nature is not the only condition for financial stability under capitalism. Most notably, far-ranging financial reform and tight regulatory oversight are imperative if there is to be any hope of somewhat stable capitalist growth. Although the present focus is on the role of government expenditure, this is not to downplay other requirements of a stable growth regime. Nor is it to defend capitalism. It could be argued that what follows underscores the unlikelihood of stable growth in the present system given the powerful political opposition currently standing in the way of sound macroeconomic policy. But, by the same token, invoking “politics” in response to macroeconomic analysis on the grounds that progressive policy will not be pursued in the absence of mass mobilization from below doesn’t really solve anything either. That same radical mobilization, and then some, will be required if we are to put in place an alternative system to capitalism. In the meantime, understanding the sectoral balance effects of different growth regimes offers some insight into the workings of the current system.…

Heteconomist
Government Spending and Financially Sustainable Growth

Peter Cooper