Do government investments produce economic growth? Nonsense! - part one

“I am right-wing, but when it comes to investments, I don’t see a solution on the right. If you have to build a factory in a place like Macedonia, for example, you can’t just rely on economic freedom and low taxes. Even if taxes were zero in Macedonia, investors would want to invest in Germany, even with the high taxes, and not in Macedonia. Therefore, the state must intervene and invest in the construction of factories. Like in Korea: The state intervened and invested in the creation of several industrial companies. Some went bankrupt, but some stayed. Without state intervention and investments, there would be no economic growth in Korea.”

I read this somewhere on Facebook. The author obviously imagines himself to be “right-wing.” This word, when it comes to political positions, means less state involvement in public life – especially in economic life, but in everything else – and more freedom for individuals, families, private businesses and voluntary organizations. Perhaps in certain limited areas he does have some “right-wing” views. But when it comes to economic growth, he simply cannot see a solution “on the right.” There is only a left-wing solution to economic growth: The state invests in building factories, and so the economy grows.

It is strange why the Netherlands, Great Britain, Switzerland and the United States achieved their economic growth at a time when there was no state investment. And it is strange why the countries with the most state investment – like the Soviet Union, for example – did not achieve any economic growth. But our “right-wing” author only notices one example, Korea.

Unfortunately, he is not alone. The idea that the state and only the state can invest in the economy to achieve economic growth, and that private investment cannot be relied upon, has taken such deep roots in Bulgarian thinking that it is very difficult for common sense to break through. And that is why, despite the repeated convincing failures of the Bulgarian state in everything it undertakes, including economic investment, the majority of Bulgarians still expect the state to “fix” them, that is, to lead society onto the path of economic growth.

So, really, is there an answer to the question of investment and economic growth that doesn't involve the state? And can we provide a convincing refutation of the leftist mantra that without state investment there is no economic growth?

There is, and we can.

First, we must be aware that the very definition of the problem, as given by our author, is left-wing. That is, the problem is posed within the framework of left-wing thinking. It is not surprising, then, that he finds only left-wing solutions. After all, the correct definition of the problem is half the solution; and if the question is posed in a left-wing way, most likely the answer will be found only in a left-wing way, simply because the very posing of the question excludes certain possible answers.

He sees economic growth only as building factories. The way leftists see it. When Marx talks about capitalism and the economy, he sees them only as factories, and accordingly divides the classes into capitalists – or manufacturers, that is, factory owners – and workers, which for him means factory workers. For the purposes of communist ideology, which insists on class struggle as the sole principle for interpreting history (see the first sentence of the first chapter of the Communist Manifesto), only these two classes matter. When leftists talk about the economy, they always have in mind a factory, or a plant, or some other kind of giant enterprise in heavy industry.

But does factory really mean “economy”?

And in Marx's time, as today, society was actually much more diverse in terms of "economic classes." Even in England, the most industrialized of all European countries at the time, factory workers were no more than 15-20% of the population, and much of the economy consisted of small firms with no more than 3-4 workers, in most cases members of the owner's own family. Marx speaks of the consolidation of capital in bourgeois society in the hands of a small group of capitalists, but such a consolidation does not exist at his time in any of the bourgeois societies he speaks of. On the contrary, Great Britain, France, the Netherlands, the United States are actually middle-class societies, with giant industrial concerns and monopolies comprising less than a quarter of the entire economy. The irony is that the consolidation of capital and wealth that Marx sought is not found in capitalist societies, but rather in non-capitalist, semi-feudal societies like Russia, Spain, or Germany, where the nobility, through their access to well-paid government positions—and not through capitalist enterprises—has the opportunity to accumulate capital. The Netherlands and the United States, where there has never been a developed nobility or state control, have a strong middle class and not many large industrial concerns, while in England, where the ideas of classical liberalism dominated in the 19th century, small business flourished.

Why is this important to us when we look at economic growth? Because we need to be aware that factories are not the only source of economic growth, and that factories have never been the same thing as the economy. The economy has always been much more than factory production, and it includes many other resources besides the industrial production of goods. It includes, for example, things like agriculture and mineral resources. It can also include intellectual capital. It can include services, many of which are intangible but quite real in the context of the global economy (for example, Switzerland with its banking services). It can include human capital, which is used both at home and as exports abroad; the Philippines and some small island countries in the Pacific mainly export labor for certain activities in other countries, and they make good money from it; and Bulgaria, for the past two decades, has received an influx of money sent by Bulgarian emigrants and workers in other countries. It can include tourism. And many other things.

Many of these resources are far more productive and profitable than building factories, and require less investment. In fact, industry—meaning factories—is not always the most productive sector when it comes to monetary returns. In the conditions of world markets, where conditions and prices change very frequently, an investment in a factory may seem very profitable today, but may turn out to be a loss tomorrow, due to fluctuations in the prices of raw materials and supplies, or in the price of the finished product, or in the price of labor. Russia or China, with their heavy industries and giant enterprises, are by no means more advanced than Switzerland with its banks and small businesses that are no bigger than workshops by Russian or Chinese standards. And the economic growth of Taiwan and Singapore came from such small workshops, not from giant concerns. Education, especially in the age of the Internet, is also a cheap investment with a high return; and if the state does not interfere in the education market with unnecessary laws or an unnecessary system of public education, the intellectual resource produced by meaningful, modern education can in itself give significant comparative advantages to even the most hopeless economy.

In short, economic growth does not require factories, and therefore government investment in factories is not necessary. Private investors have plenty of options, and not all of them necessarily require billions of dollars and many years. Factories can be left to backward nations that lack the imagination and freedom to invest, such as China and Russia.

Second, economic growth does not depend on the availability of material resources, or even intellectual resources. This statement would seem strange to many who are not familiar with the true nature of economics and economic development. But a quick comparison between Russia and Hong Kong would explain things very quickly: Russia, with its developed infrastructure, heavy industry and energy, vast deposits of almost all the most important mineral resources, numerous world-class universities and scientists, vast expanses of arable land near vast water sources, with a system of roads and railways and river routes to facilitate local and international trade, with a climate that makes its European part the most fertile region on earth . . . continues to lag significantly behind the West in terms of entrepreneurship, productivity, GDP per capita and income. Hong Kong, with a monstrous population density, no natural resources and no arable land, no world-class universities or scientific potential and discoveries, and for many years isolated commercially from its only neighbor, China, continues to rank first in GDP and per capita income. (Another example would be Switzerland, or the Netherlands in the 16th and 17th centuries.) Regardless of your views on different economic systems, the facts about the differences between Russia and Hong Kong should be enough to dispel the myth that the mere presence of any economic resources – such as factories – can produce economic growth and prosperity. There must be something else that is the real factor in economic growth.

And indeed there is. For lack of a better word, economists and economic historians call it innovation. It is the ability of the human mind to find new ways to produce new and better products to satisfy people's needs, with ever more efficient use of material and immaterial resources. Machine production, of course, is one example of such an ability: several technological discoveries, produced by the efforts of scientists and technologists, were brought together to create the technology of the conveyor belt and mass production. The discovery of electricity and its ability to transfer energy over great distances - compared to the transfer of mechanical energy - is another example. But such technological discoveries can operate not only in industry. Agriculture has been a field of technological discovery since the late Roman Empire: the heavy plow and three-period tillage, the application of fertilizers, and the transition from the use of oxen to horses in agriculture are examples of technological developments that seem somewhat trivial to us, but for their time were technological revolutions on the same level as the automobile is today. All of these technological innovations are simply ways of better using resources to produce more or better products or services, or new products or services that no one had thought of before.

And these innovations do not come by themselves. They are the product of human minds. Without the power of the human mind to invent new things being unleashed, there is no economic growth. A simple investment in factories today, or in more oxen in the past, will not lead to economic growth if the conditions for this unleashing of the potential of the human mind are not in place. After the conquest of Egypt in the 7th century, the Arab caliphs inherited the most technologically advanced and well-maintained irrigation system in the world at that time, which for two millennia before had served as the breadbasket of the Mediterranean and Europe. (The comparison today would be the conquest of Germany and its entire industrial and transportation infrastructure.) Within a generation, the irrigation systems were in complete disrepair, and Egypt, until then a food exporter to the entire Roman Empire, was facing its first famine years in its history since the time of the biblical Joseph. Being a stagnant religion, Islam was incapable of producing anything but stagnant minds; and regardless of inherited investments, there is no economic growth, because it comes solely from the abilities of the human mind to invent and put inventions into practice, and keep them working for generations.

The mere construction of a state-owned factory cannot produce these qualities of the human mind, nor can it liberate its creative powers. A man must be motivated to put his mind, his efforts, and his abilities to work; and given human nature, this can only happen when a man is free to keep for himself the fruits of his efforts, that is, the profits of his activity. That means being free from robbery and other violence. And state taxes are robbery—the most enterprising and successful suffer from them. In order for the state to invest in its enterprises, it must rob the fruits of the labor of people who could invent and invest their abilities and efforts in private enterprises. This kills innovation. Ultimately, a country in which the state invests in factories is a country with a lot of useless factories, because the people lack the motivation to maintain them, develop them, and invent new ways to produce new and better things at a lower cost. To know what I mean, think “the USSR.”

Stay tuned for a sequel...

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