There was a time when private investment, always a prerequisite for economic growth, was very simple, when "shovel ready" actually meant something, and a family could buy a shovel and a few other hand tools and begin clearing a piece of land and cutting timber for logs and turning the earth over for planting. The dollars they spent on the tools and land and their free labor comprised the capital investment needed to get a productive farm in place. That was an example of seriously delayed gratification.
But once an economy is up and running and progresses beyond providing basic food and shelter, investment becomes a bit more complicated though no less essential. Investment is the fuel for job creation and for corporate earnings and wages and salaries and consumer demand and for the taxes that can be collected on those benefits and for government spending it enables. And those after-tax business earnings become available to meet new investment opportunities. And the cycle continues. The key is to get GDP growing at a healthy rate, and the primary engine for that is private investment. Click on the diagram for a better view of the components of GDP.
And, unfortunately, that private investment is the lowest it has been over the past 50+ years, comprising less than 10% of GDP.
It is hard to know what has to happen first. Sales people like to say that nothing happens until somebody sells something. Manufacturing people say it starts with making something. Scientists and engineers give the credit to inventing and designing. Business people put the emphasis on investing in plants and equipment. And, it is often argued that the US economy is consumer driven. Some even argue now that government holds the key and needs to borrow more from China to provide additional stimulation. So, in a way, all but the last are correct, but right now business people are taking major heat because they are sitting on lots of cash and not investing it in plants and equipment. Why not?
I think there are four inter-related and mutually reinforcing reasons, all of which would concern me a great deal if I were a private company owner or executive or officer with fiduciary responsibility and money to invest.
- Uncertainty about the tax and regulatory environments
- Low consumer demand and confidence
- Concern about the national debt and impending inflation
- Uncertainty about interest rates and equity values
The federal government has done considerable short-term tweaking to provide tax relief, actions such as reducing the payroll tax for a limited time and at least attempting short term extension of at least some of the so-called Bush tax cuts. It has also extended unemployment and launched a major Food Stamp marketing campaign. But these short-term fixes simply increase uncertainty about what the tax and regulatory environments, consumer demand, federal deficits, interest rates, and equity values are going to be over the next ten years, the time frame of interest to anybody making substantial investments.
That uncertainty has a double whammy because it further undermines consumer confidence. People are uneasy about what their health care costs are likely to be over the next few years under the new ACA. They don’t know what their tax brackets will be or how much inflation to expect. Both businesses and individuals hear that we are building the national debt at a rate of more than a trillion dollars a year, and common sense says that is unsustainable and will lead to financial disaster, probably in the form of inflation which will destroy those bank accounts that are now paying near zero interest. And, having suffered through the market collapse of 2008-09 and then missing at least part of the recovery, people with money to invest are very leery of the equity markets at their current high levels.
To get the economic engine going, we need some certainty including permanent corporate and personal income tax reform establishing lower marginal rates and few or no deductions, exemptions, exclusions, or credits. It would be fine for there to be a reasonable net increase in current tax revenue because we need it for deficit reduction, but the important thing is that tax on additional profits and earnings must be at a lower rate indefinitely. And we need interest rates to come up a bit so people with money, retirees included, can earn some interest and pay taxes on those earnings. And we need a little regulatory relief and a promise that there aren't going to be any surprising regulatory increases over the next ten years.
If we get such changes from Washington, all the things that need to happen will begin to happen, and the death cycle we are currently locked in can become a growth spiral. Consumers and business people will be more confident, investment will increase, consumption will increase, GDP will grow, and debt as a percent of GDP will begin to decrease. Profits and earnings and tax revenues will all grow. That is really our only way out other than rolling up the sidewalks in a campaign of extreme frugality aimed at debt reduction and resulting in even more contraction of the economy. We have to grow our way out of the problem by being more competitive and working harder and producing and selling more.
Otherwise we may have to start moving to the country, buying little plots of land and shovels, and digging. I’m afraid most of us will find ourselves poorly equipped for survival in such a situation.
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