Monday, June 11, 2012

Larry Summers On Public Investment And Debt

Larry Summers has a reputation. He was a key figure in the deregulation of US finance in the late 1990s, as Treasury Secretary under the Clinton administration, that ultimately led to the banking crisis of 2007-2008. As President of Harvard, he was accused of sexism, conflict of interest, and carried responsibility for the university’s nearly US$2 billion in losses from derivatives trading. Professionally, he’s known as being acerbic and dismissive towards others – arrogant is one of the kinder words used. His academic work tends towards supporting free market, Republican views, despite serving two Democratic presidents.

But Larry Summers is also one of the smarter economists of his generation. Right or wrong, he presents some really thought provoking ideas. And he’s also surprisingly pragmatic (excerpt; emphasis added):

Is the global economy returning to a path of healthy growth?
Comment by Lawrence Summers

WITH the past week's dismal US jobs data, signs of increasing financial strain in Europe, and discouraging news from China, the proposition that the global economy is returning to a path of healthy growth looks highly implausible…

…The question is, what should be done? To come up with a viable solution, consider the remarkable level of interest rates in much of the industrialised world. The US government can borrow in nominal terms at about 0.5% for five years, 1.5% for 10 years, and 2.5% for 30 years.

…In real terms, the world is prepared to pay the United States more than 100 basis points to store its money for five years and more than 50 basis points for 10 years…Remarkably, the United Kingdom borrowed money last week for 50 years at a real rate of 4 basis points…

…Many in both the United States and Europe are arguing for further quantitative easing to bring down longer-term interest rates…

…However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to undertake with rates reduced by yet another 25 or 50 basis points…

…So, what is to be done? Rather than focusing on lowering already epically low rates, governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more, not less, and investing in improving their future fiscal position, even assuming no positive demand stimulus effects of a kind likely to materialise with negative real rates. They should accelerate any necessary maintenance project issuing debt leaves the state richer not poorer, assuming that maintenance costs rise at or above the general inflation rate

…These examples are the place to begin, because they involve what is in effect an arbitrage, whereby the government uses its credit to deliver essentially the same bundle of services at a lower cost. It would be amazing if there were not many public investment projects with certain equivalent real returns well above zero…

…This logic suggests that countries regarded as havens that can borrow long term at a very low cost should be rushing to take advantage of the opportunity.

To provide some context, as director of Obama’s National Economic Council, Summers favoured tax cuts for the 2009 US stimulus program. Here instead, he’s talking about public investment – a 180 degree turnaround. In economic ideology terms, this is like von Hayek saying Lord Keynes was right. I’m reminded of what Keynes was once reported to have said, “When the facts change, I change my mind.”

The important lesson here is that current low borrowing costs means public investment is cheaper now than ever before. In Malaysia’s case, 20 year government borrowing yields are half what they were  ten years ago in real terms.

The more important lesson here is that optimal economic policy depends on context and circumstance. There is no policy approach that will be correct all of the time, at all places. And that argues for economics education that is less ideological, and more comprehensive – including the contributions of “heretical” schools of thought such as Austrian and Post-Keynesian.

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