Larry Summers’ Goofball Economics

By David Stockman

Its no wonder governments are broke and central bank money printers are going wild throughout much of the developed world. They are unfortunately listening to the kind of goofball economics that issues from Keynesian economists like Larry Summers and his clones and confederates at the IMF.

But their latest missive is so over the top that even
JM Keynes himself must be rolling in his grave. According to Summers and the IMF, public infrastructure spending should be exempt from fiscal discipline because it pays for itself and, in fact, generates $3 of output for every dollar spent. Not to be outdone by the departed supply-side maniac, Jude Wanniski, Summers claims infrastructure spending is an out-and-out “free lunch”:

What is crucial everywhere is the recognition that in a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions.

Here’s how the Great Summers reckons. First, he says you need to “assume that the investment earns a 6 per cent real return”. He then notes that government will take about 25% from the income produced, meaning that 1.5% of that real return on public investment will end up in the treasury’s coffers.

Next Dr. Summers observes that “interest costs less inflation (i.e. real) are below 1 per cent in the US and much of the industrialised world over horizons of up to 30 years”. Yes, thanks to the Fed’s financial repression they are actually negative for most of the yield curve and has been for years under ZIRP and QE.

In any event, apply some second grade math by subtracting the <1 percent interest cost from the 1.5 percent tax receipts and, walla, there is a positive real spread on public investment which can now be used to pay down the national debt.

Breathtaking! So government should get on with it and spend-up a storm. The way to reduce swollen deficits is still that old Keynesian canard—- that is, spend your way to prosperity!

Nor is Summers a small-time thinker. He claims that injunction is a universal truth that applies to virtually every government in the world “possibly excepting China”. Hmmm. After an orgy of infrastructure spending that makes the ancient pharaohs seem like skinflints, Summers says, possibly China should be excepted?

It puts you in mind of the story about an economist and friend who tumbled into a 30-foot deep hole. The friend inquired about the economist’s plan for getting out and the latter replied, “First, assume we have a ladder”!

Like the legendary economist, Summers has simply “laddered” his way through the whole analysis. To wit, there is no reason whatsoever to assume that public investment as practiced in crony capitalist democracies produce any return to society, let alone 6% after inflation, or that sustainable real interest rates could possibly be under 1%.

Indeed, the overwhelming evidence of history and logic goes entirely in the opposite direction. Namely, that actual returns on public investment are decidedly lower than the ultimate carry cost of the public debt, and that a public investment spree would therefore compound the fiscal disaster already upon us.

So start with the preposterous assumption that public investment produces a real return of 6% annually. During the last decade and one-half  Congress has appropriated an average of $5 billion for public works projects and $8 billion for mass transit. At the 8% nominal return stipulated by Summers  2% inflation plus 6% real), these “investments” would have generated returns of $150 billion by now.

What kind of crackpot would believe such a thing? Water projects produce virtually no public benefit and for the most part simply shift private activity from say trucks to barges–meaning that there is no gain in output to tax. And self-evidently, mass transit capital investment generates huge annual losses—a truth underscored by the large operating subsidies paid each year by taxpayers.

In all his years in Washington, Professor Summers self-evidently never attended a Public Work Committee mark-up and watched our K-street lobbyists and PAC-oiled process of governance at work. So unless public investment is completely and honestly funded with user fees—-that is, interest groups are made to bear both the costs and the benefits—- it does not have a remote chance of producing a 6% real return, or any return at all.

Needless to say, Congress is not remotely interested in raising user fees to fund public projects. The highway trust fund which was originally enacted on a strict user fee basis is now hopelessly in debt to the general fund because outlays of about $45 billion per year are not even remotely covered by the $30 billion in receipts generated by the gas tax.

But then Summers and the IMF are not interested in raising user fees either.The whole public investment thesis is just a smokescreen for more deficit spending—–in pursuit of the tired old Keynesian formula about stoking “aggregate demand”.

But growth and wealth do not come from “aggregate demand”; they arise from work, production and enterprise. Growth occurs when society supplies more resources to the production process and uses them more efficiently.

The last thing that fits that description is pork barrel spending by Washington.  At the end of the day, there is no evident shortage of productive infrastructure in the United States. The Interstate Highway system, for example, is in decent shape in most of the country and could be improved with a modest increase in the gas tax where it isn’t up to par.  The same is true of harbors, airports and municipal water and sewer systems: Where they are not up to snuff—-let actual users foot the bill for any needed improvements.

But don’t pretend that deficit funding of Washington’s innumerable pork barrels has anything to do with needed public infrastructure or private sector economic growth. Don’t pretend that public debt is cheap—under 1% in real terms—because for the moment the Fed is creating a phony low yield through its massive money printing campaigns.

And most especially don’t listen to the simple-minded Keynesian advice of Professor Summers and the IMF. Washington has been listening to them for decades, and its the reason that the American economy is failing to produce real growth and prosperity.

 David Stockman was the Director of the Office of Management and Budget during part of the Reagan Administration, from 1981 to 1985. He is the author of The Great Deformation: The Corruption of Capitaism in America and The Triumph of Politics: Why the Reagan Revolution Failed.

 The above originally appeared at David Stockman's Contra Corner and is reprinted with permission.