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Against Investment-Driven Growth

The Economics of Over-Ripe Capitalism

by ALAN NASSER

“We have now grown used to the idea that most ordinary or natural growth processes (the growth of organisms, or populations of organisms or, for example, of cities) is not merely limited, but self-limited, i.e. is slowed down or eventually brought to a standstill as a consequence of the act of growth itself. For one reason or another, but always for some reason, organisms cannot grow indefinitely, just as beyond a certain level of size or density a population defeats its own capacity for further growth.”

— Nobel geneticist Sir Peter Medawar, The Hope of Progress

There is a consensus across the entire political spectrum that renewed net investment -costs incurred for the purpose of making net additions to capital, i.e. additions over and above what it costs to maintain or replace existing capital stock- in productive capital is necessary if we are to come out of the current depression, restore employment and provide working people with the standard of living they deserve. Radical analysts lament the relative decline of productive investment and the skyrocketing of financial-speculative investment that marked the end of the Golden Age of postwar growth. We are to believe that the surplus that is currently channeled into financial speculation in derivatives and foreign exchange markets, or sitting idle in the coffers of giant private enterprises, should be diverted back to productive investment, which in turn would make possible economic restoration. And how could the resumption of robust rates of productive investment not be the major priority? After all, private investment is the Let There Be Light of the world of material production. It initiates production, employment, profits and wages. But don’t be fooled; this story is nowhere near as compelling as it may seem. And its implications for wage growth are, as we shall see, grim.

It is essential to this story that we are talking about private investment. The surplus that is to be diverted from finance to production and employment is privately held, by financial and non-financial corporations. What is suggested is that if the financial manipulation of the surplus were discouraged, either by restoring Glass-Steagall and/or by imposing a heavy tax on financial transactions, these private funds would naturally seek the only alternative,  productive investment.

This argument depends entirely on a key assumption which the historical development of capitalism has rendered obsolete. The pivotal premiss is that sustaining production and employment under capitalism hinges on perpetually commiting additional portions of the private surplus to additional investment in new kinds of capital goods, for example green technologies, or more efficient versions of existing equipment. ‘Additional’ or ‘net’ here means ‘investment funds over and above what is required to replace existing equipment’, that is, funds in excess of depreciation allowances. The latter are set aside by firms for the purpose of maintaining, repairing or replacing equipment already in place. These funds intended to cover capital consumption are not counted as profits and are accordingly not taxed. Hence, net investment is supposed to exceed depreciation charges and is therefore financed from profits, as are outlays to pay wages and salaries and to reward mere ownership, e.g. dividend payouts. The alleged ongoing need for net investment is in fact a major element in the justification of profit as necessary to fund investment. Should it turn out that the maturation of industrial capitalism has rendered net investment over and above depreciation set-asides unnecessary to sustain production and employment, then not only must we radically alter the way we think about the exit strategy from the current depression, but we are also led to question the most fundamental rationale for the existence of private profit itself.

The prevailing myth about the indispensability of net investment is a casualty of failing to understand the major transformations of the role of investment in the historical development of twentieth-century capitalism.  As we shall see, the myth of investment involves the very odd notion that mature capitalism exhibits precisely the same investment-driven growth dynamic that characterized capitalism  during its period of industrialization, or basic capital formation, from roughly 1860 to 1899. An historical overview of the function of investment in the maturation process of industrial capitalism should make this clear.

Investment-Driven Growth in Nineteenth-Century Industrializing Capitalism

The distinctive character of nineteenth-century economic growth underscores the historically specific function of net investment in capitalist development. The overriding national project during the last four decades of the nineteenth century was basic capital formation. The task was to build the fundamental industrial infrastructure of the republic, to effect the accumulation of capital, the maturation of the country’s productive powers. A period of industrialization therefore necessitated a special pattern of resource allocation. The lion’s share of national income had to be committed to the growth of the capital goods industry, which amounted to continuous investment in, predominantly, railroads and steel. (Total railroad investment alone in this period exceeded all investment in manufacturing.) This meant that the portion of national income devoted to wages and consumption had to be kept relatively low in order to finance basic capital formation. Present consumption was sacrificed in order to enlarge future consumption. The kind of explosive production of consumption goods that we saw in the 1920s was not yet possible as long as the principal project was to develop the means of industrial production.

Investment-led growth over an extended period came at a heavy price. The very nature of the project was frought with contradictions. Strategic capital goods such as transport networks and steel mills cannot be built bit by bit in response to consumer demand. The formation of an industrial infrastructure requires that capitalists invest ahead of demand. Huge fixed investments with large sunk costs were made in an atmosphere of unbridled price competition. Prices were frequently driven down below marginal cost, so that fixed expenses could not be covered. The result was extensive excess capacity in rails and steel and a continuous wave of business failures. By the end of the century fully half of all rail lines constructed since 1860 had gone into bankruptcy or receivership. This epoch of competitive investment was the most economically turbulent in US history. From 1867 to 1900 there were eight business cycles. Over those 396 months the economy expanded during 199 months and contracted during 197.

These were necessary growing pains. If a high level of investment was to be sustained over decades with a low level of consumption demand, the imbalace must and did take its toll. Happily, the classical economists understood that the inequality and instability built into the process of industrialization was a temporary affliction that could and should come to an end with the attainment of economic maturity. The normal operation of the price mechanism would eliminate the sources of both chronic instability and gross inequality. Here is how it was supposed to happen.

An industrializing economy eventually becomes industrialized; the demand for the output of the capital goods sector eventually diminishes. This must bring about a falling rate of profit and thereby a simultaneous check on accumulation and spur to consumption.

The causal chain was thought to be evident: the fall of the profit rate would lower capital’s share of national income, i.e. would transfer income from capital to labor. Thus, the demand gap created by the waning of the demand for capital goods would be made up by the increase in wage-driven demand, which would mean an expansion in the output of consumption goods. Moreover, an immediate expansion of consumption at the expense of accumulation would be feasible in some cases given the adaptability of certain key capital-goods industries to new market conditions resulting from the newly-expanded purchasing power of the working class. The construction of new factories could, for example, yield to the construction of new homes. The end of railroad expansion by 1907, which contributed to the sluggish growth of 1907-1914, could be offset by the expansion of the new automobile industry.

The Ongoing Redundancy of Labor and Capital in Mature Capitalism

The significance of the lessons to be learned from the logic of investment-driven growth cannot be overestimated. Economists concerned with the growth process look at the capital-output ratio, the amount of capital, i.e. the magnitude of financial outlays for capital goods, compared to the value of output turned out with that quantity of capital. How much capital is required to generate a given level of GDP? During industrialization, we expect that the capital-output ratio will rise. And rise it did. The percentage share of GNP of gross and net investment rose steadily from 1839 to 1898. But a perpetual rise in the rate of capital accumulation relative to GDP growth is not to be expected, because an industrializing economy eventually becomes industrialized, at which point the rate of capital accumulation slows down. And slow down it did. Simon Kuznets, the inventor in the 1930s of what remains the most widely used system of national income accounting, demonstrated that the ratio of net investment to national income (GNP) declined steadily after 1910 until net capital formation was reduced to nearly zero during the Great Depression.

This historically salient developmental transformation was reflected in major changes in twentieth century capitalism’s growth process. Not only was less additional capital required once the basic industrial anatomy of the economy was finally formed, but the cost of capital goods had declined during the normal course of technical development. The capital goods industry had developed exactly as the consumer goods industry would develop upon its maturation during the 1920s: an increasing number of both kinds of good was produced with a decreasing amount of labor. During that decade automobile output increased 255 percent with no addition to the auto work force. Between 1919 and 1929 labor productivity in manufacturing increased by 43 percent; in automobile production it soared by 98 percent. Likewise, at the very beginning of industrialization the capital goods industries were initially labor-attracting. But as capital formation proceeded, the production of productive equipment became more efficient, requiring decreasing numbers of worker per unit of output. Productivity in the capital goods sector increased continually, just as it would later on in the consumer goods sector.

That is exactly what we should expect. Capital goods are costs of production, and capitalism requires constant efforts to reduce production costs. Everyone understands this in connection with the production of consumption goods. But the principle applies no less to the production of capital goods. This was understood by the most prominent authentic Keynesians of the twentieth century. Anatol Murad reminded us that “Even as… new invention resulted in a machine capable of turning out twice as many shoes with a given amounbt of labor, so it is likely to result in a machine capable of turning out twice as many shoe machines.”

Our attention is drawn here to the need to rethink our notion of replacement or depreciation expenditures. The textbook implies that replacement is merely a substitution of the worn out or disrepaired machine with a new one, the way we replace a worn-out battery with a new one.  But in the real world, replacement involves more than mere duplication; replacements are frequently more efficient than what they replace. (Economists call this the “revaluation” of the capital stock.) Replacement is financed out of depreciation reserves, which are not counted as part of profits, and replacement investment has been since 1910 a growing share of total investment. Thus, as Robert A. Gordon has noted,

“Business firms do not ordinarily replace old equipment with new units of identically the same kind… [A] larger fraction of [total investment]…is financed automatically out of depreciation charges. Such investment requires no net saving… [T]he larger replacement expenditures, with continuing technological change, the greater the possibility of having a steady increase in output with no net investment at all...[T]he capital stock does not have to grow in proportion to the rise in output.” (emphasis added)

Simon Kuznets underscored the same point in the seminal 1951 paper “Long-Term Changes in the National Product of the United States of America Since 1870”:

‘mere “replacement” may signify increase in productive capacity…a rise in the ratio of capital consumption [depreciated equipment] to total output means, other conditions being equal, a declining need for net additions to capital stock.’ (emphasis in original)

Finally, Evsey Domar, co-author of the widely acknowledged Harrod-Domar Model of economic growth,  showed that the replacement requirements of a growing economy are less than depreciation charges, so that a portion of the resulting saving from depreciation can finance innovations that both expand capacity and reduce costs of production.

The point can be made by means of an example familiar to just about everyone. Means of production, capital goods, are like computers: over time they become both more efficient and cheaper. Everyone understands that capitalism generates ever more productive equipment, and seeks always to reduce costs of production. This includes all costs, of both human and non-human “inputs”. The conclusion leaps out that investment-centered capitalism tends to commit suicide by pushing the need for net investment toward zero.

In a 20-page Appendix to the economic historian James Livingston’s 2011 book Against Thrift, Livingston and economist Steve Roth demonstrate with exceptional rigor and a mountain of data that in the US net investment has in fact been in secular decline since 1910. The implications challenge the way many of the most perceptive radicals think about capitalism and the current crisis.

The Atrophy of Net Investment: Overhauling Our Thinking About the Economics of Overripe Capitalism

The obsolescence of investment-driven capitalism was apparent in transformations in the dynamics of the business cycle after industrialization. From capitalism’s beginnings in the US in the early nineteenth century, up until the 1920s, every recovery from a cyclical contraction was led by investment spending and the corresponding restriction of consumption. The rail, steel and manufacturing barons had leaned heavily on bankers for large loans to fund massive fixed investments. It was during the nineteenth century that finance capital first enjoyed its heydey as the US ruling class. But as industrialization was accomplished and the capital stock became both abundant and cheaper, companies’ profits grew, business failures declined dramatically, and the working capital of giant corporations was no longer insufficient to finance further large-scale investment. Many companies accumulated enough working capital that they were able to finance themselves instead of resorting to borrowing. Retained earnings became a major source of productivity-enhancing investment. Commercial loans extended by the banks declined and industrial capital rose to ruling status in the 1920s.

By the second decade of the twentieth century private investment was no longer the driver of recoveries out of contractions. The restriction of consumption was no longer necessary to generate economic growth. During the 1920s, and in every business cycle since then  -every one-  recoveries have been driven by increases in consumption demand, not investment spending. The 1920s marked a major turning point in human history: for the first time it was now possible to increase both production and productivity with no increased investments in labor or capital. The demand for consumer durables, especially automobile and automobile-related spending, drove the expansion of the Second Gilded Age.

The recovery of 1933-1937 exhibited the fastest growth rates of the twentieth century and it too was fuelled by consumer spending. The consumer demand that drove this exceptional recovery was made possible by public, not private, investment. It is not investment as such that capitalist development renders otiose, but private investment. The New Deal public spending that grounded the 1933-1937 expansion counts as a form of investment, but it was not this investment as such that brought about the recovery. It was the purchasing power these outlays vested in working people that constituted the effective demand that spurred the ’33-‘37 expansion, during which banks had stopped lending and net investment had evaporated.

The anatomy of economic growth since 1919 contradicts the prevailing wisdom among both mainstream economists and just about all radicals. It goes against the grain, this idea that net private investment is now barely relevant to production. So much the worse for the grain. Since the early twentieth century the principal drivers of growth have been consumption demand and government spending. These are now the only sources of growth that will not perpetuate inequality. What is required if working people are to receive their just desserts as producers, a wage adequate to a good life, is a variant of what we saw during the New Deal, adapted to present circumstances.

Investment and consumption are drawn from the same fund, namely the national income. We have seen that prioritizing investment as a requirement of economic health comes at the expense of consumption. Investment has been supposed to be financed out of saving, standardly defined as that portion of income, national or household, that is not consumed. Saving and investment represent the “sacrifice” or “abstention” required of us before we may be permitted to savor the fruits of investment and production.

Livingston has correctly described this conceit as a dopey moral homily, not an economic principle. Labor-saving machinery and capital-saving innovations, by making it possible to finance new investment for less than it costs to maintain and replace existing stock, make it unnecessary to withhold a significant chunk of national income for purposes of additional investment. All such withholdings are subtractions from public and private consumption. As such they constitute a drag on growth, which has been for almost a century now been propelled by consumption. More precisely, they represent neoliberalism’s own form of growth, growth by redistribution.

Policy motivated by the myth of investment-driven growth perpetuates inequality. The Fed’s injections of liquidity have stimulated neither consumption nor investment. The prescription for reducing inequality is exactly what the classical economists recommended, wage-driven growth. We should be explicit: the demand for wage-driven growth, minus the propaganda about the need for additional investment funds, is a demand far more radical than we have been used to. We announce that profit net of depreciation is useful only for payouts to “investors”, speculation, wasteful and uninformative advertising and marketing, and payments to corporate attorneys. None of this represents a “contribution to production”.

Neither Marxian nor textbook theory has developed a model of capital accumulation without net investment. An historically updated account would substitute the wages of labor for investment as the Let There Be Light. The result would be Laborism, not Capitalism. When investment is the initiator of the economic process, the latter is organized and directed to satisfy the interests of investors, the class of owners of Big Wealth. But when the economy is driven by those whose contribution to production earns them wages, the economic priorities are democratically determined by those who work. That should be the bottom line of democracy, and it is not compatible with the capitalist organization of the economy, nor with any conception of economic growth as any longer investment-driven.

Keynes recognized this in his way. He understood profit over and above what was fair as a reward for real entrepreneurial contribution, i.e. over and above the entrepreneur’s earned salary, to be an exploitation of the scarcity-value of capital. But at a certain point  -within the generation after Keynes’s writing, he thought-  capital would become no longer scarce. Thereafter, Keynes argued, much of investment would be socialized or directed by political injunction toward social purposes, and the inequality necessary to accomplish capital formation would disappear.

A pointed measure of the non-scarcity of capital is that the profit expected from a net addition to society’s productive capacity  -not its ability to expand marketing and advertising strategies or to employ property and antitrust lawyers or to pay dividends to investors whose only “contribution” to production is owning paper assets-  is close to zero. This would be the case when additions to capital stock can be financed by depreciation reserves. Here is Keynes:

“The situation, which I am indicating as typical, is one in which capital is so abundant that the community as a whole has no reasonable use for any more… [A] state of full investment [is one in which] an aggregate gross yield in excess of replacement cost could no longer be expected on a reasonable calculation from a further increment of durable goods of any type whatsoever. Moreover, this situation might be reached comparatively soon – say within twenty-five years or less.” [The General Theory, 321, 323-324, emphasis added]

The Radical Implications of the Atrophy of Net Investment

With twenty-five percent of the population at or below the poverty level and more Americans than ever, nearly one in seven, on food stamps -now the nation’s largest social welfare program-  the need for a massive boost in aggregate consumption driven by public investment and high wages is a no-brainer. That a mature industrial economy can generate substantial profits, i.e. revenues over costs, with no net additions to capital stock is a measure of the very broad range of social needs to which the surplus can be directed. According to a recent Commonwealth Fund report one in four adults is saddled with medical expenses that render them unable to pay for basic necessities such as food, heat or rent due to medical costs. Almost half of US adults between 19 and 64—an estimated 84 million people—did not have health insurance for all of 2012, or had coverage that did not adequately protect them from high health care costs. And we know all about dilapidated infrastructure and pressing education needs.

Meeting all these needs involves a huge boost to public investment, the only kind of investment any longer necessary to the reproduction of society, and to both public and private consumption. The embryo of such an economic order is already in place as a necessary means to sustaining capitalism under conditions in which private capital is the economic equivalent of our bodily appendix. Government supplements to private consumption, in the form of transfer payments, make up twenty percent of total household income. And this is not merely a function of the current crisis. In 1930, private investment was fifty percent greater than total public spending, but by 1970 public spending was fifty percent greater than all private investment. Capital’s developmental dynamic is such that a more rational society cannot help but form in its womb. But its full gestation is not likewise inevitable. Only the political pediatrics of active organization will give birth to the new.

The Keynes the “Keynesians” don’t talk about understood that the shift from capital accumulation to consumption would constitute a massive social-cultural transformation including, but extending far beyond, the mere economic:

“All kinds of social customs and practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard.…When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues…. The love of money as a possession – as distinguished from the love of money as a means to the enjoyments and realities of life – will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.” (Economic Possibilities For Our Grandchildren, emphasis added)

The economic dimension of such a transformation would include the large scale use of public investment to accomplish what private capital has no use for:

“In cases of proved necessity, we should not be opposed to measure of compulsion…. [E]fficiency and forethought might be much increased if a body… designated [as] the Board of National Investment, in the hands of which all matters relating to the deliberate guidance of schemes of long-term national investment would be concentrated.” [Collected Writings, vol. 20, 306-307]

Note Keynes’s claim that laying the groundwork for a society no longer based on the accumulation of capital would require a “measure of compulsion”. He imagined that the inevitable resistance of the wealth-owning class would have to be overcome by the political authority of the Board of National Planners. He did not envisage the development of a State effectively owned by and committed to the bidding of private capital. He will be forgiven for not taking account of the future neoliberal State. But we won’t. Keynes was right about the necessity of political compulsion in order to effect the kind of society most people want. But he misidentified the political agent. “We have met [that agent], and it is us.”

Alan Nasser is Professor emeritus of Political Economy and Philosophy at The Evergreen State College. This article is adapted from his book, The “New Normal”: Persistent Austerity, Declining Democracy and the Globalization of Resistance, to be published by Pluto Press later this year or early next. If you would like to be notified when the book is released, please send a request to nassera@evergreen.edu <mailto:nassera@evergreen.edu <mailto:nassera@evergreen.edu> >

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