In October, 2011, two leading U.S. economists, Nobel prize-winner Paul Krugman and Lawrence Summers, squared off in Toronto in the high-profile Munk Debates. At issue was the question of whether North America faced a Japan-style era of prolonged economic stagnation.
Mr. Summers, former Treasury secretary under president Bill Clinton, a key White House economic adviser in President Barack Obama’s first term, former president of Harvard University, and for a time a highly paid adviser to a leading hedge fund, is as close to an establishment economist as one can get. He was widely reported to be President Obama’s personal choice to replace Ben Bernanke as chairman of the Federal Reserve Board, and probably would have been nominated if not for strong opposition from the many Democratic senators who saw him as too close to Wall Street.
In that debate two years ago, Mr. Summers argued that President Obama’s temporary economic stimulus program had worked, and that low interest rates would prevent the long-term stagnation scenario feared by pessimists such as Mr. Krugman. So it comes as something of a surprise that he basically switched sides and joined the “stagnationists” in a widely reported speech to an International Monetary Fund conference on Nov 8.
Mr. Summers now argues that the “natural rate of interest,” the real interest rate needed to bring the U.S. economy back to full employment with price stability, is significantly below zero. Moreover, he argues that this was the case even before the Great Recession, when there were no inflationary pressures and significant unemployment in the midst of what turned out to be an unsustainable financial bubble fuelled by cheap credit.
As has been widely noted in the economics blogosphere, this puts Mr. Summers squarely in the camp of those who argue that even ultra-loose monetary policy cannot get us out of long-term stagnation, and that we must turn to fiscal policy to deal with the problem. Indeed, even before his IMF speech, Mr. Summers had published a major paper with Brad De Long arguing for more debt-financed public investment to promote a stronger recovery.
Meanwhile, here in Canada, the economy also continues to operate well below potential despite near-zero short– and long-term real interest rates. And prospects for a more robust Canadian recovery driven by exports and business investment are clearly not very rosy if Mr. Krugman and Mr. Summers are correct and the U.S. economy, by far Canada’s largest market, continues on a very slow growth trajectory.
But here in Canada, one hears very little talk of a needed shift in fiscal policy away from austerity. Certainly the Harper government maintains a laser-like focus on eliminating the federal deficit by 2015 through deep spending cuts and a cap on transfers to the provinces. This approach remains the conventional wisdom on Bay Street and in the mainstream media.
The fiscal policy choice we face is often miscast as one between austerity to deal with public debt and short-term Keynesian-style stimulus. But the real choice, Mr. Summers argues, is whether or not to finance public investments that would have positive long-term impacts on both the economy and on public finances.
Take the case for repairing or replacing Canada’s crumbling basic municipal infrastructure, some 30 per cent of which is reported by the Federation of Canadian Municipalities (FCM) to be in “fair” or “poor” condition. The problem was dramatically highlighted by the need for emergency repairs to Canada’s busiest bridge in Montreal last week, part of a costly and highly disruptive maintenance program for the Champlain Bridge that will be needed to patch things up until a long-postponed new bridge is built.
While the last federal budget renewed the Building Canada Fund for another 10 years, there was no increase in modest federal funding for basic municipal infrastructure. And the Parliamentary Budget Office reports that a significant share of the $10-billion of “lapsed” federal spending last year came from lower-than-projected infrastructure investments.
Underinvestment in infrastructure to meet an arbitrary short-term deficit reduction target makes absolutely no economic sense. As the FCM argues, it is more costly to postpone needed repair and renewal of infrastructure, especially in a slack economy when the work can be done relatively cheaply and can be financed at near-record-low interest rates.
A major boost to federal public infrastructure investment today might increase the deficit under accounting rules that do not (unlike in the private sector) allow for amortization of assets over time. But future gross domestic product would be higher, lowering the real burden of debt.
For example, a new Champlain Bridge, now promised to be completed by 2021, will have much lower operating costs, will improve business productivity by reducing punishing travel and commuting times in Montreal, and will lower the cost of transporting exports to the United States. Building the bridge as soon as possible will boost GDP, in both the short-run construction phase and in the long run.
In a stagnant economy, one marked by low levels of private investment despite near-zero interest rates, the best way to boost growth and job creation is through increased public investment. The case for public-investment-led growth is particularly compelling when such investments have a high rate of return, and thus reduce public debt as a share of the economy in the long term.