(This is an archived extract from the book Patterns of Power: Edition 2)
The activity of wealth creation typically requires an initial capital investment:
· Most companies need land, buildings, tools, machines and office equipment – though some of these may be rented from other companies which had previously invested.
· Companies also need connections to suppliers and customers with some form of infrastructure: transportation, communications etc.
· A company may need to invest in research, to develop new products.
These all affect a company’s competitiveness, so they have to be maintained and updated. The supply, rental and maintenance of them are further wealth creation opportunities. Private investors provide most of the finance to establish wealth-creation activities in a capitalist economy.
The country as a whole benefits when more wealth can be created, so there are several situations in which governments may want to provide the funding for capital investment in facilities, infrastructure and research:
· Governments may feel that it is in the national interest to make a cost-justifiable infrastructure investment sooner than the private sector would do. They can accept a slower pay-back than financial markets would expect.
· A government can act as a coordinator where it might be difficult for disparate companies to collaborate in the provision of collective infrastructure, notably for very large projects or where the pay-back would be slow.
· It can also help with the need for compulsory purchase of land.
· It can directly fund research, but there are problems in knowing what is needed. Government research programmes have helped to set the direction of the economy in several countries,[1] but the increasing pace of change and the global nature of competition make it more likely that the commercial sector will see opportunities and provide resources.
· It can also fund research indirectly, as part of defence procurement for example, with later spin-off benefits to other industries. The spin-offs are difficult to predict though, so it is not easy to claim them as cost justifications.
· A government can time its investments to counteract some of the effects of a recession, as a macroeconomic policy decision (this is described in 3.3.8.2).
· It might want to assist less developed areas of a country – which is the purpose of the European Regional Development Fund (ERDF), for example.[2]
Such government involvement (which is the 4th category of government spending as listed in section 3.2.3) is more politically acceptable to collectivists than to individualists – though Adam Smith, who is not thought of as a collectivist, recognised its importance.[3] From a purely economic perspective, some government investment can be cost-justified – but that has to be determined on a case-by-case basis.
© PatternsofPower.org, 2014
[1] In 1969 Jȕrgen Habermas was able to write (in Toward a Rational Society, chap. 4 p. 59):
"The pace and direction of technical development today depend to a great extent on public investments: in the United States the defense and space administrations are the largest sources of research contracts. I suspect that the situation is similar in the Soviet Union."
The dominance of the American computer industry has been widely attributed to defence research programmes, but more recent spectacular improvements in computer technology have been fed largely by the commercial sector’s response to booming consumer demand.
Ha-Joon Chang quoted the example of South Korea’s economy, whose growth was initially directed by its government in a manner which would have been inconceivable as a bottom-up market-driven initiative yet it was very successful (Thing 12, in 23 Things They Don't Tell You About Capitalism).
[2] In April 2014, the European Regional Development Fund (ERDF) website was at http://ec.europa.eu/regional_policy/thefunds/regional/index_en.cfm.
[3] Some individualists acknowledge that government involvement is occasionally necessary, as in this quotation from Adam Smith’s book An Inquiry into the Nature and Causes of the Wealth of Nations (Book IV, chap. 9, para. 51):
“According to the system of natural liberty, the sovereign has only three duties to attend to; three duties of great importance, indeed, but plain and intelligible to common understandings: first, the duty of protecting the society from violence and invasion of other independent societies; secondly, the duty of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice; and, thirdly, the duty of erecting and maintaining certain public works and certain public institutions which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expence[sic] to any individual or small number of individuals, though it may frequently do much more than repay it to a great society.”
The book was available in April 2014 at http://www.econlib.org/library/Smith/smWN.html