Publisher's note: This article appeared on John Hood's daily column in the Carolina Journal, which, because of Author / Publisher Hood, is linked to the John Locke Foundation.
John Hood, president of the John Locke Foundation.
RALEIGH - As North Carolina and the rest of the country continue a painfully slow recovery from a painful recession, there is no more important question in public policy than how best to create sustained economic growth.
There is no shortage of ideas about the nature and sources of growth. But most of them can be grouped into three general theories. For convenience sake, let's call them the growth theories of the Left, the Center, and the Right.
The Left believes that the driving force behind economic growth is consumption. According to this theory, recessions occur because people stop buying sufficient goods and services to keep the economy running at top speed. Instead, for whatever reason, they save their money. That reduces aggregate demand, then sales, then employment and incomes.
This demand-side theory of economic failure suggests a demand-driven theory of economic success. The Left argues that government should prop up aggregate demand by deficit-funded spending - on everything from schools and roads to unemployment insurance and Medicaid. The Left further argues that, because poor people tend to spend a higher percentage of their annual incomes than the wealthy, government should redistribute income to reduce overall savings and, thus, boost consumer demand.
Both the Center and the Right disagree with the Left. Instead of focusing on the demand side of the economy, they focus on supply. They argue that economic growth flows from effective investment in capital assets - in plants, equipment, infrastructure, ideas (intellectual capital), and better-educated, better-trained people (human capital). According to supply-side theories of economic growth, recessions occur not because consumers suddenly forget to spend but because of a growing disconnect between what companies produce and what consumers desire. The disconnect may arise from unforeseen changes in technology or consumer preference, the fate that befell even the most efficient, innovative buggy manufacturer of 1910. Or the recession-inducing disconnect may arise from faulty monetary, fiscal, or regulatory policies that bias investment decisions, such as those that favored residential housing over other, more-productive forms of investment during the 1990s and 2000s.
While they share a supply-side focus on investment rather than consumption, the Center and Right disagree about whether policymakers should focus on fostering public investment (government spending on schools and roads) or private investment (capital formation by households and businesses). Virtually no one in the Center believes that only public investment matters. Virtually no one on the Right believes that only private investment matters. The debate is about the proper balance between the two.
The gap is actually far wider between the Center-Right and the Left. There is also a wide gap between the Left and reality. While both the Center and Right can claim some empirical support for their views, the overwhelming majority of peer-reviewed studies
show that government spending on consumption subsidies such as Medicaid is a net negative for economic growth, all other things being equal.
Frustrated liberals tend to ignore the "all other things being equal" part. They point to places with higher-than-average welfare spending and higher-than-average economic performance as examples of the Left's demand-side theory in action. But they fail to notice what else is going on. In Northern European countries, for example, governments do tend to have extensive safety-net programs. But they also tend to maintain pro-growth tax and regulatory policies that result in productive private investment.
According to World Bank data
, for example, the ratio of consumption to investment is relatively low in countries such as Luxemburg (1.6), Norway (1.7), the Netherlands and Belgium (2.4), Sweden (2.5), and Denmark (2.6). On the other hand, the United States has the highest consumption-to-investment ratio (4.5) in the developed world. Not coincidentally, the U.S. has the highest corporate tax rate and among the highest investment-tax burdens in the developed world.
Northern European countries don't have better economic performance because they have safety nets. They have better economic performance for other reasons, which boosts household living standards while generating enough revenue to fund their safety nets.
I don't think America can or should import their model in all its particulars. But we can adopt public policies friendlier to investment such as alleviating the regulatory burden and slashing tax rates on capital formation. In 2013, North Carolina took some welcome first steps. It will prove to be a good investment in our future.
Hood is president of the John Locke Foundation, which has just published First In Freedom: Transforming Ideas into Consequences for North Carolina. It is available at JohnLockeStore.com.