The Problem with Spending; Government Deficits Strangle Capital Formation
Byline: Richard W. Rahn, SPECIAL TO THE WASHINGTON TIMES
Even though the government is running massive deficits, interest rates and inflation are low. So, what's the problem? The following discussion will clarify the problem. Next week, I will explain the consequences of this reckless spending, and the week after, what we should do to right our economic ship.
How fast an economy can grow is largely a function of the quantity and quality of labor, and the amount of investment funds available for what economists call capital formation. Good, high-paying jobs cost money. You don't have truck drivers if no one has the money to buy trucks. More capital investment and more research and development (R&D) per worker usually enable workers to produce more per hour, which makes them more valuable and hence, able to command higher wages. The greater the number of people making higher wages, the greater the demand by these people for more goods and services, which, in turn, creates many more jobs.
The amount of investment capital available is largely a function of the quantity of savings provided by individuals and businesses (both domestic and foreign) and government. Individuals save and invest to protect themselves against loss of income, unanticipated expenses, and for such things as cars, vacations and retirement. Businesses save in order to weather downturns and invest in new plants and equipment and more R&D.
As can be seen in the accompanying table, the total amount of savings available for investment (as a percent of gross domestic product) has fallen sharply over the past decade. Individual and business savings have risen, but this rise has been swamped by the deficits in the government sector, and this is not likely to get much better. (Remember, in the late 1990s, the federal and many state and local governments were running surpluses, which enabled them to pay down their debt.)
The United States is now in a situation in which the government is taking a very large share (40 percent) of the nation's savings to finance its deficit spending, leaving a diminished pool of capital to meet the needs of both families and businesses. You might be thinking, if there are not enough savings available for investment needs, why are interest rates so low? The answer is that the Federal Reserve (Fed) has been creating money by loaning the banks nearly free money and buying mortgages from Fannie Mae and Freddie Mac. …