Nobel laureate Michael Spence lays out the case for higher productivity-enhancing public investment when aggregate demand is weak, as negative demand shocks continue to emerge from: (i) excessive debt used into unproductive activities, or that they have not led to much productivity gains, leading to excess debt and falling asset prices; and (ii) demand suppressed by high unemployment in Europe along with the excessive regulation of non-tradable sector in Japan, both constraining economic activities.
Structural reforms are hard to implement in the short-term. Stabilization measures are usually the medicine for short-term demand deficiency.
The solution for now: jack up productivity-enhancing public investment.
That brings us to the third factor behind the global economy's anemic performance: underinvestment, particularly by the public sector. In the US, infrastructure investment remains suboptimal, and investment in the economy's knowledge and technology base is declining, partly because the pressure to remain ahead in these areas has waned since the Cold War ended. Europe, for its part, is constrained by excessive public debt and weak fiscal positions.
In the emerging world, India and Brazil are just two examples of economies where inadequate investment has kept growth below potential (though that may be changing in India). The notable exception is China, which has maintained high (and occasionally perhaps excessive) levels of public investment throughout the post-crisis period.
Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fueling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns. Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns.
And, monetary policy alone won’t be sufficient. Fiscal policy together with structural reforms are essential:
Though monetary stimulus is important to facilitate deleveraging, prevent financial-system dysfunction, and bolster investor confidence, it cannot place an economy on a sustainable growth path alone – a point that central bankers themselves have repeatedly emphasized. Structural reforms, together with increased investment, are also needed.
Given the extent to which insufficient demand is constraining growth, investment should come first. Faced with tight fiscal (and political) constraints, policymakers should abandon the flawed notion that investments with broad – and, to some extent, non-appropriable – public benefits must be financed entirely with public funds. Instead, they should establish intermediation channels for long-term financing.
At the same time, this approach means that policymakers must find ways to ensure that public investments provide returns for private investors. Fortunately, there are existing models, such as those applied to ports, roads, and rail systems, as well as the royalties system for intellectual property.
The way to do this would be: (i) G-20 nations increase public investment; and (ii) multilateral and regional development institutions mobilize private capital to fund public investment.
That is why the G-20 should work to encourage public investment within member countries, while international financial institutions, development banks, and national governments should seek to channel private capital toward public investment, with appropriate returns. With such an approach, the global economy's “new normal" could shift from its current mediocre trajectory to one of strong and sustainable growth.
A lesson for Nepal: Increase both the quantum and quality of capital spending first. It is just 3.3% of GDP right now. It need to be increased to at least 8% of GDP in the medium term and also GFCG has to be bumped up to around 30% of GDP. The other associated point is that such investment has to be productivity-enhancing.