Economists never have arrived at a satisfactory theory for weighting the various factors that affect investment. The cost of borrowable funds is certainly one of them, but only one. Taxation may also have important effects on investment incentives: if the returns from investment are increased by tax reduction, investment will increase. That is the central point of supply-side economics. It is a good point in the abstract, but the relative weight of the tax effect remains open to debate.
Perhaps the most important determinant of investment, however (so most economists of the 1950s and 1960s held), is the demand for products produced by new plant and equipment. If, for example, demand for automobiles is expected to increase, Ford or Honda may invest in a new plant. Whether Honda will do it in Honshu or in Ohio is a question that suggests that economic policies must increasingly be considered on the international level. Regardless, market demand remains a crucial factor in determining investment. And fiscal policy contributes directly to market demand. If the economy is operating at less than full employment, then increased government spending or tax reduction or both can increase demand for goods and services and consequently increase investment in capital goods to make products to supply the demand.
Which economic policies will best increase productivity and growth thus remains an issue much more open than is suggested by current orthodoxy. President Clinton, Senator Bob Dole, Federal Reserve Chairman Alan Greenspan and Vice-Chairman Alice Rivlin, point in one direction: balance the budget to reduce competition for investable funds. Some very respectable economists but few politicians, in the United States or elsewhere, point the other way: increase investment by increasing demand.The Fallacious Family
THE whole story, however, like all policy stories, is primarily one of politics, not economics. Deficit spending has been considered politically dishonorable for a long time -- before, during, and after the Keynesian heyday. The reason is expressed in the observation that elected officials enjoy the benefits of spending on voters but abhor the penalties of imposing taxes -- and thus the political incentives that encourage irresponsible deficit spending must be controlled, perhaps even by a balanced-budget amendment.
The popular analogy is to a spendthrift family borrowing to live beyond its means. That analogy is dubious, for three reasons.
First, even thrifty families borrow for long-term purposes, many of which -- their children's education, for example -- may be expected to increase future income. A substantial part of federal spending is similar: it is investment to increase future national income. Indeed, more than half of the states' constitutions require balanced operating budgets, but they separate out capital budgets to allow borrowing for long-term investment projects.