Wrong Fiscal Policy
Fiscal policy is heavily biased in favor of consumption over investment. The conflict between consumption and investment can be simply summed up in the old adage, "You canÕt have your cake and eat it too." In economic terms, society cannot invest in ownership of wealth producing factories for the future, if it spends all its current income on VCRs, big houses, and fancy cars.
Consumption
Consumption is the ultimate goal of all economic activity. Consumption is the means by which consumers satisfy their needs and desires. However, consumption cannot be pursued by itself alone because nothing can be consumed until it is first produced.
Production
Production is the economic activity that produces goods and services. Production generates the wealth that enables consumption. If more wealth is produced than consumed, the net stock of wealth increases, and society grows richer. But, if more is consumed than is produced, the net stock of wealth decreases, and the nation gets poorer. Stimulating consumption without increasing production is therefore not the way to prosperity -- it is the road to poverty. Only if production equals or exceeds consumption, is prosperity possible.
Herein lies a fundamental dilemma. While consumption is the ultimate goal of economic growth, consumption uses up the wealth which must be invested to enable economic growth. Thus, economic policies that focus primarily on consumption will fail in the long run to achieve prosperity, because consumption uses up the investment capital needed to create prosperity. The inevitable end result of over-consumption is declining productivity, physical decay, and increasing poverty.
Inadequate investment in the United States is, to a large extent, a legacy of Keynesian economic theory that has dominated U.S. economic policies since the 1930Õs. Keynes (1936) treats consumption as the engine of economic growth and neglects the importance of productivity and the effect of investment on productivity growth. KeynesÕ theory was formulated during the Great Depression when over-supply was viewed as a serious threat to economic recovery. In that era, newspapers were filled with stories of farmers pouring out milk and burning potatoes in an effort to drive up prices, while millions went hungry. The problem was seen as inadequate consumer demand. The logical solution was to give hungry people jobs so they could buy food. The recommended policy was to Òprime the pumpÓ, or stimulate the economy with government spending.
From the beginning, Keynesian economic policies focused primarily on demand; and they still do. The impact of investment on productivity growth is largely ignored, and saving is treated as something to be avoided -- at least by the state, if not the individual. Today, the legacy of Keynes remains strongly embedded in economic policies. Although it is becoming widely recognized that economic growth is positively correlated with the rate of investment, policies that might produce a high rate of saving and investment are lacking. Lip service is paid to the importance of saving, but few incentives to save have actually been implemented. Most economic policy still is designed to encourage consumers to spend money, not save it. For example, interest paid on home mortgages and home equity loans, is tax deductible, while interest earned on savings, and dividends paid on most investments, are fully taxed. More importantly, income taxes have been cut, and benefits raised on a host of entitlement programs to the point where the federal government is currently borrowing about $250 billion per year to meet current operating expenditures. This is negative savings. It is a scam that enables the current generation to consume more than it produces -- and send the bill to its children.
Many Americans believe that social security taxes are a form of saving, and rely on social security and Medicare for financial security. Many people are shocked to learn that none of the money collected by social security taxes is saved or invested, but is converted directly into consumption through benefits paid to consumers or into government bonds that finance current government operating expenses. Nothing is saved. Nothing is invested. Furthermore, most recipients receive far more in benefits than they pay in taxes.
The bottom line is the U.S. has the lowest savings and investment rate of all the industrialized countries in the world. This guarantees slow productivity growth, and hence, slow economic growth.