Business Investment Preferences THE GEORGE WASHINGTON LAW REVIEW tionary pressures fueled by heavier business capital expenditures surely increase the resistance to federal investment spending. An overriding issue regarding total investment is the nature of the saving function, a matter surprisingly ignored on occasion. Early Keynesian analysis raised serious questions as to the elasticity or proportional response of saving to changes in the rate of interest or other measures of its rate of return. Contemporary analysis has, in fact, underscored these questions. Dominant views of economists regarding the determinants of savings tie them to the "permanent income" formulation of Friedman29 and the basically analogous life cycle model of Modigliani.30 While both envisage effects from the return on saving, they bring to the fore the more basic considerations of providing for a lifetime of consumption. Indeed, the mixture of income and substitution effects resulting from higher rates of return after taxes continues to leave ambiguous the very direction of response to changes in rates of return on saving. Put simply, we save out of income in the primary income-earning years of life in order to have wealth available for consumption during retirement or other future periods when current expenditures are likely to exceed current income. A higher rate of return makes us able to meet relatively fixed future needs with less current saving. Paradoxically, business investment in plant and equipment as well as other capital accumulation might receive more stimulus from certain measures, at first thought far afield, that might have major impact on private saving. In particular, the motive for much saving is to provide for retirement. Our increasingly comprehensive Social Security system tends, desirable as it may be—and I do not want to be interpreted as opposing Social Security-to obviate some of the need for private saving. It is not necessary to put aside income now to provide for the future if retirement expenses will be taken care of by the government. Of course, employer and employee contributions for social insurance deprive households of income which might otherwise be spent in consumption, but current Social Security payouts have compensated for this. Moreover, recent substantial increases in Social Security benefits and in associated medical assistance have tended to make traditionally defined consumption expenditures higher than they would otherwise be. In an economy operating close to full capacity, given existing institutional arrangements, increased consump 29. FRIEDMAN, A THEORY OF THE CONSUMPTION FUNCTION (1957). 30. Modigliani & Brumberg, Utility Analysis and the Consumption Function: An Interpretation of Cross-Section Data, in POST-KEYNESIAN ECONOMICS 388 (Kurihara ed. 1954). tion must come from somewhere, and as we trace the involved interrelations in our complex economy we can expect to see some fallout on business investment. Hence, if we really want to stimulate investment, we might well consider sacking the Social Security system! By reserving less for comfortable years of retirement and less for medical services, more resources can be made available for machines and factories. And if American households cannot expect to be taken care of by their government, they can be expected to save more themselves for the rainy days in the future, entrusting their savings, directly or indirectly, to investment in profit-making enterprises. Usefulness of the Tax Preferences Suppose the investment tax preferences were more effective than I indicate, or suppose that they were made so massive that they would bring about substantial business investment in any event. What would the added business investment accomplish? If the economy were suffering from inadequate aggregate demand and large scale unemployment, the increase in investment would raise total demand, output, and employment. The same result could be accomplished by other fiscal and, perhaps, monetary measures that might do less to distort resource allocation, but this is not the issue currently posed. Rather, it is argued that we need more business investment to increase the rate of growth, presumably of productive capacity, which it is implicitly assumed will be utilized, and to modernize our productive facilities so as to improve our "competitiveness in the world market place."31 Let us consider these arguments in turn. Böhm-Bawerk argued persuasively for the greater productivity of more "roundabout" or capital-intensive methods of production. The pail is more productive than the hollow of a man's hand in collecting water from the spring. And the "runnel or rhone which brings a full head of water" to the man's cottage is more productive still.32 But should the peasant be given a tax incentive to build large tanks, a reservoir, or a dam for his own use? Not so clear! Surely not every capital addition is worthwhile. Not every new plant or new piece of machinery adds to future products more than its own cost. Yet, in making investment decisions apart from tax considerations, businesses must pick among all possible capital expenditures those that promise sufficient advantage. Why should they be persuaded by special tax preferences to incur capital expenditures that would not appear sufficiently advantageous without such preferences? Indeed, the basic notion underlying Böhm-Bawerk's view of the in 31. See, eg, Madden, Is Our Tax System Making Us Second-Rate, 26 NAT'L TAX J., 403 (1973). 32. EUGEN VON BOHM-BAWERK, POSITIVE THEORY OF CAPITAL (1891), excerpted in READINGS IN ECONOMICS 30-32 (Samuelson 7th ed. 1973). Business Investment Preferences THE GEORGE WASHINGTON LAW REVIEW crease in productivity from using capital for more roundabout production is precisely that in a free market, decision-makers would be acquiring those additional units of capital that would pay for themselves in added production and pay enough more to justify the delay in current satisfaction while the investment is undertaken. If an additional unit of capital costing $100 returns in discounted future value $105 of additional output or cost savings, it will be profitable for the businessman and a benefit to the economy as a whole. In general, tax concessions for investment, if effective, induce business to sacrifice the economy's opportunities for current consumption to invest for future consumption at terms that consumers would not accept freely. At the extreme, if the marginal rate of time preference were zero-if we were indifferent as between additional units of future or present consumption-incentives for investment would be attempts to induce business to acquire units of capital which would pay back less than their own original costs: 100 units of final output now would be sacrificed to get 95 units later. This is a path of decay, not economic growth! The arguments for subsidizing business investment to improve competitiveness in world markets are no better. For they generally ignore the basic principles of international trade and competition that go back to the law of comparative advantage enunciated early by the great classical economist, David Ricardo. Given free exchange rates, the poorest economy in the world, with the most obsolete plants, will find itself "competitive" in some products and unable to meet foreign competition in others. Even a nation less productive in all commodities than the rest of the world will find it profitable for itself and the rest of the world to produce and export those goods which it can produce at a lesser absolute disadvantage, or comparative advantage, and import those goods which it can produce at a greater absolute disadvantage. Making such a nation more productive by providing additional capital may increase trade to the extent it increases total output and income. It will not, however, provide the nation with a greater capacity to undercut the rest of the world. As productivity increases and costs come down, the foreign exchange rates will adjust. The nation will still find it more profitable to produce and export those commodities in which it has a comparative advantage and to import those in which it has a comparative disadvantage. Of course, comparative advantages may shift from one industry to another. And this may be precisely the effect of business investment incentives on competitiveness with foreign producers. A direct subsidy to one industry or one set of industries may well enable it to sell more cheaply abroad. The increased foreign demand for the product of the subsidized industry implies an increased foreign demand for dollars and a higher price of the dollar in terms of foreign currencies. This in turn will make all American products more expensive for foreigners, thereby injuring the "competitiveness" of products of unsubsidized industries. Tax incentives for business investment have precisely this kind of effect indirectly. They tend to decrease costs most for capital-intensive industries which benefit most from the tax subsidies. The products of these industries will then be more competitive in foreign trade, but only at the expense of the products of less capital-intensive and less subsidized industries which suffer more from the increased cost of the dollar to foreigners than they gain in decreased costs of production. While business investment tax preferences do not make American goods generally "more competitive," they do make it easier for some (capital-intensive) goods and harder for other goods to compete. In so doing, they shift some production from goods in which, by free market criteria, we are more efficient, to goods in which we are relatively less efficient. They thus lower real income and the standard of living for the country as a whole. If, for example, American agriculture, and grain producers in particular, experience a huge, unmanipulated demand for their products, giving the United States an export balance that raises the value (cost to foreigners) of the United States dollar, thus making it more difficult for at least some American manufacturers to sell abroad, we should not subsidize those manufacturers. To do so is to divert resources from grain production, in which we are more efficient, to the use of less efficient manufacturers. These manufacturers, and their workers, may well prove gainers, but it is not only the grain producers but the nation as a whole, on balance, that will prove the losers.33 All this shades into the broader issue of when and where it is desirable to have government intervention, by controls or tax policy, in the workings of the economy. It is perhaps strange that many selfproclaimed business spokesmen, presumably wedded to the virtues of free enterprise, are quick to espouse government intervention in the form of tax preferences from which they believe they will gain. But free enterprise has more virtues than are apparently recognized by some of its supposed adherents. Most economists recognize the need for government action in the way of general fiscal and monetary policy to establish the conditions for full employment, hopefully with reasonable price stability. They further recognize the need for government action to preserve workable competition where that is possible, and to regulate quasi-monopolies where competition is unfeasible or prohibitively costly. They also recognize the need for government intervention to improve the flow of information essential to intelligent purchasing, whether of securities or cigarettes. 33. Arguments relating to international considerations are discussed more fully in Eisner, Investment, Obsolescence and Foreign Competition, CONFERENCE BOARD RECORD, reprinted in VITAL SPEECHES 285-88 (Feb. 15, 1972). Business Investment Preferences THE GEORGE WASHINGTON LAW REVIEW And they recognize increasingly the need for government intervention in instances where capital markets are seriously imperfect or externalities are involved in production or consumption. These last considerations suggest a major government role in assuring sufficient investment in human capital, in education and training, and in health. Since in a non-slave economy human capital cannot readily be sold, nor under our laws can its product be readily indentured, it does not pay private producers to invest in it to the extent that its productivity may warrant. The owners and prospective owners of human capital correspondingly may have insufficient access to funds, confidence in their prospects, and willingness to bear risk to lead them to invest sufficiently in themselves. Furthermore, investment in human capital frequently has external effects which benefit others than those who embody the investment. A more educated population may, for example, be less productive of crime. Somewhat analogously, investment in research and development takes on much of the aspect of a public good. New ideas, new techniques, and know-how are not easily appropriated for long periods by their discoverers. Benefits to the economy may thus considerably outweigh those that can be retained by original investors. In this situation, also, society or government is called upon to subsidize private investment or to undertake it itself. A hint as to the relative impact or significance of the "intangible" investment that does not usually profit from business investment preferences was given in a classic article by Robert Solow, who reported some years ago that only a small portion of growth and output in the United States economy could be accounted for by increases in the usually observed inputs of labor and capital. The major share of growth was accounted for by a trend factor "T," which has been taken by some to stand for technical progress, but which may better be seen to encompass all of the many elements of investment, human and non-human, which do not get the benefit of tax preferences. Government intervention may well be justified to encourage much non-business investment. In addition to child-rearing, education and training, job mobility, health, and research and development, it may be desirable to encourage public investment or subsidize private investment in our natural resources, in our environment, and in all of the large-risk but vital overhead capital which makes the functioning of a modern economy possible. And we may further see 34. See Solow, Technical Change and the Aggregate Production_Function, 39 REV. OF ECON. & STATISTICS, 312 (1957). See also Denison, The Sources of Economic Growth in the United States and the Alternatives Before Us, Supp. Paper No. 13, Comm. for Econ. Development (1962). |