Sunday, 26 October 2008

Investment versus liquidity preference and luxury consumption

The statement by 16 monetarist economists published in the Sunday Telegraph opposing state investment to deal with the financial crisis goes right to the heart of economic theory and social interests in the present economic situation. Therefore the left should understand exactly what is wrong with it.
A recession appears in the form of, although it is not ultimately caused by, a collapse in demand in the economy. However the two fundamental sectors of the economy, consumption and investment, are driven by different factors.
Leaving aside the international sector, and in the present situation the decline in the exchange rate of the pound should increase export demand, private consumption is driven by income of the population, as individual saving is low compared to income, while state consumption (health, education etc) is driven by government decisions. Both do not undergo precipitate declines in a recession.
Investment however, in the present economy, is driven by the private drive for profit - state invesment is too low a proportion of the economy at present to stave off an investment collapse.
It is for this reason that tax cuts to companies are ineffectual in staving off recession. Tax cuts may be used not to increase investment but either in luxury consumption by company owners (dividend payments, bonuses etc) or to increase cash balances without carrying out investment (liquidity preference). Only state spending ensures either that consumption is sustained or, more important, that investment is carried out.
For this reason a state programme of investment, not tax cuts, is the only way to ensure that the fall in investment, and therefore the decline in demand in the economy, is minimised.


Alun Griffiths said...

I really think that you have to start looking more closely at idea around Political Ecology if the SEB wants to present some sort of coherent analysis and proposals to move forward towards a better society and world.

So I will launch that debate and quote "Anybody that thinks that exponential growth can continue indefinately in a finite world is either, a fool, or an economist."

Emily said...

Consumption and investment should be balanced. When you spend money spend wisely but for satisfy your needs. When you invest money invest more wisely to satisfy your future needs and causalities.