A capital idea for growth

by John Hood, John Locke Foundation and NC SPIN panelist, April 6, 2015.

If you want to understand the debate about how best to promote growth within a capitalist society, start with the root word: capital.

Although economists continue to differ widely and strenuously about what causes short-term events such as recessions and recoveries, few would disagree with the proposition that capital formation is a fundamental building block of long-term economic growth. But what is capital?

The concept is broader than just an accumulation of financial assets. Of course companies and individuals need money to buy things. But what things? A capital good is something formed and purchased not for immediate consumption but to help us produce goods and services for future consumption. It can be a factory, a machine, a tool, a computer, even a musical instrument.

Think broader than that, though. An industrial process or patented invention is a form of intellectual capital. A well-educated, well-trained person is a form of human capital. Whenever we forego immediate consumption and invest our time and money to make ourselves more productive, we create capital.

Governments can affect the formation of capital in many different ways. They can invest in capital goods such as roads or water systems. They can also use tax money to invest in the formation of human capital, too, with the crucial difference being that physical capital can be publicly owned but human capital is always private (in a free society, at least).

These are examples of how governments may foster capital formation. However, they can also hamper it. Tax codes that fail to distinguish immediate consumption from investment, and then levy high marginal tax rates on the latter, can either encourage taxpayers to save and invest less than they otherwise would or encourage them to do their saving and investing somewhere else. Governments also hurt capital formation when they impose regulations in which the costs exceeding any health or safety benefits.

Unless you believe in either anarchy or totalitarianism, then you must think there is a proper balance between public investment and private investment. Some government spending on infrastructure and education creates enough valuable public capital to offset the negative consequences of levying the required taxes. At some point, however, an additional dollar spent on roads or schools does not produce as much value as the same dollar spent on private capital (including private investment in education and training, by the way).

For policymakers who aren’t just playing political games or stumbling around the dark, the real debate is about where that tipping point lies. Liberals tend to think North Carolina, and America as a whole, spends too little on government. Conservatives tend to think we spend too much on it, that we’re well past the point of diminishing returns.

It won’t surprise you to learn that I side with the conservatives here. Even though North Carolina spends less per student on K-12 education than most states do, we still spend more than most of the European and Asian countries whose students outperform ours. On average, they get a better return on their investment. And to say that North Carolina’s economy benefitted substantially from the three big waves of road-building in our history — the 1920s, the 1950s, and the 1980-90s — is not necessarily to say that an expensive new wave of construction would be worth the cost.

These are empirical questions. They’re hard to answer, but not impossible. The preponderance of academic research suggests that North Carolina will get a higher rate of return from new private investment than from new government investment. A study released just last month by two University of Arizona researchers provides additional support for that conclusion. Examining state-by-state data from 2000 to 2008, they found that private capital was two to three times more economically productive than public capital. They further discovered that more state spending on education had become a net negative — that the taxes required did more harm than the additional spending did any good.

Obviously infrastructure and education are important. This is an argument for spending more wisely on them, rather than just jacking up their cost. I think it’s a capital idea.

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