Michael Keating. Capitalism and the Economy.

As both John Menadue and Ian McAuley have argued in recent posts there are good social reasons for governments to intervene to modify the outcomes from a purely capitalist economy. Right now rising inequality and taxation avoidance by companies and wealthy people are priority issues that should be addressed. It is also possible that the impact on the government budget from increasing inequality could have a negative impact on future economic growth.

I think, however, it is going a step too far to suggest that capitalism is leading to low wages which then result in a shortage of demand, and that this is the reason for the failure of business investment and economic growth to pick-up, especially in the US.

The fact is that currently – and indeed for decades – US domestic investment has been greater than US savings. The difference between the two is identically equal to the US current account deficit, which amounted to as much as 6 per cent of GDP immediately prior to the GFC, and is still running at around 2 ½ per cent of GDP notwithstanding generally sluggish domestic demand and a significant depreciation of the US dollar.  So the US is not short of demand in aggregate, although some might prefer a different pattern of that demand. Instead it is arguable the US needs to reduce its reliance on other people’s savings. Indeed with China holding around 40 per cent of US government debt, this is hardly the basis for an independent foreign policy and maintaining US supremacy in the Asia-Pacific region.

But what is required to restore a better balance between investment and savings in the US, and also in many other capitalist economies which are relying on the savings of foreigners?

One view, most prominently promulgated by Larry Summers, a former Secretary of the US Treasury, is that there is an excess supply of savings in the world.  Accordingly action needs to be taken to reduce the global savings rate, even if that is not true for many rich capitalist countries.

To the extent that excess global savings are a problem, the principal country responsible is China. Furthermore, China has been over-investing and many of its domestic investments are under-utilised. But if investment in China is more closely related to demand in future, potentially there could be even more flows of Chinese savings to the US and elsewhere.  Interestingly China agrees, to at least some extent, and its economic strategy envisages increasing consumption and lowering both investment and particularly savings. So effectively there is a measure of international agreement that the present global economic imbalances are not because capitalism has been paying wages that are too low, but rather because communism has been doing this.

The question then is what consequences would flow from a better global balance between savings and investment. In the US the reduction of the current account deficit would require some combination of a real exchange rate depreciation and increased savings. Both of these changes would reduce US consumption but this reduction could be more than offset by increased foreign demand and less reliance on imports, so that economic growth would be likely to pick up. But returning to our starting point, an increase in US wages and consumption is not the way to restore the health of the US economy.

For those of us who favour a more equal distribution of income an increase in minimum wages may well have a role in the US, where the minimum wage is very low, but only if it leads to an improvement in the relative wages of low paid people, and not an across-the-board increase in wages generally. A more lasting solution is to improve the skills of people on the margin of employment so that they can obtain the jobs of the future. It is in this respect that capitalism is too often at fault and risks being unsustainable unless it is prepared to make greater efforts to train people, and to train them not just for today’s jobs but also so that they can move easily to tomorrow’s jobs.

Michael Keating was formerly Secretary of the Department of Finance, and Secretary of the Department of Prime Minister and Cabinet.


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