Wednesday, November 16, 2011

Keynes Investments

During Keynes' lifetime there was no distinction made between Public sector and Private sector investment in economic theory.  Investment was investment.  In fact, Keynes justified increasing Public sector investment to replace diminishing Private sector investment after the stock market crash of 1929.  Treating investment in the Public and Private sector as equivalent seems like an obvious oversight on his part.  Certainly some types of investment are more likely to spark increased economic activity than other investments.  For a private investor choosing the right investment depends on the degree with which an investment will increase in value.  This is especially true of a stock market investment and less so for a bond purchase, but the potential increase in value of each investment plays a major role in the selection of which product to purchase.

Keynes, on the other hand, only followed the investment cycle from a savings account into a private company or into a public agency where the funds were used to pay a salary or purchase a product.  He gave no further consideration to what happened to the money after this transfer, but it is the next step that sparks economic growth.  If the money ends up in a business it is likely part of a process of profit making.  Profit expands economic growth.  If the business segment is growing the company may use the funds to leverage additional business loans.  Business loans have the potential to increase investment capital tenfold when a bank uses the Federal Reserve System.  This path is much preferred to a company simply paying an employee's salary.  The employee might use the funds to pay his federally insured mortgage or send his salary into another investment dead end.  Such an investment in our current situation does earn anyone a profit, and therefore, is economic growth neutral.  Unless the salaried employee purchases a product from a company making a profit and growing, there is no resultant economic growth.  For instance, an employee spending most of his money on food from subsistence farmers is not expanding the economy by spending his salary.  This type of exchange is a barter level trade.

Only Private sector investment advances economic growth.  The federal government of the United States calculates economic growth by the rate of GDP growth.  Unfortunately, federal expenditures from tax collection and borrowing are part of GDP.  Does this make sense?  It does not.  Imagine if there was no Private sector and all expenditures were from borrowed funds and the government increased their expenditures 12% per year.  Would you believe the government that economic growth was increasing by 12%?   The way GDP figures are used this would be correct, but it isn't.  Government expenditures should never be part of GDP.  Economic growth is the increase in the profitability of the Private sector.  From the government perspective if economic growth is 12% their tax revenues should increase 12%.  From the Private sector perspective under this scenario businesses will know the size of the market for goods and services will increase 12%. 

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