Investment Does NOT ‘Weigh Down’ Economic Growth

by Don Boudreaux on October 22, 2007

in Balance of Payments, Trade

Here’s a letter of mine, published today in the Washington Times:

Incessantly repeating that “U.S. growth… has been weighed down by soaring deficits with China” does nothing to render true this false bit of conventional wisdom (“China won’t adjust currency,” Page 1, Saturday). Indeed, it is false on too many levels to list here.

Most fundamentally, the flip side of a rising U.S. trade deficit is a rising U.S. capital-account surplus — meaning a hefty inflow of capital into America. More capital means lower real rates of interest. Lower real rates of interest mean more investment. More investment raises worker productivity. Rising worker productivity raises real wages. And rising real wages enable Americans to enjoy higher and higher standards of living.

Department of Economics
George Mason University

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vidyohs October 22, 2007 at 9:14 am


""For me, the obvious solution is to stop deficit spending but I don't see how that will ever happen with today's political climate…""

I couldn't agree more about the desirability of ending deficit spending entirely, and I agree about today's political climate.

However, I have a question for Don.

Is our deficit spending a Tiger we are riding, and what affect would ending deficit spending at this time have on the economy of this nation but of the world?

Wojtek Grabski October 22, 2007 at 9:50 am

This is a self-regulating system: If foreigners really did find America's industry not worth the investment, then the dollar value would drop to match their fears, and deficit spending would fall alongside that change — due to reduced purchasing power.

So long as foreign good are cheaper, then the whole notion of eliminating deficit spending is tantamount to telling Americans to 'buy less'. It's ridiculous.

spencer October 22, 2007 at 10:42 am

Your argument is based on the premise that the foreign capital inflow is used to finance investments. But the large structural federal deficit and the low level of US savings implies that a very significant share of the foreign capital is being used to finance consumption rather then investment. So while under certain limiting assumptions your argument is valid, many of those assumption do not hold in the current environment.

If you take out a second mortgage to finance your kids college it is a good investment. But using that same second mortgage to finance a family vacation is not much of an investment. Much of what we are doing with the foreign capital inflow is more like financing a family vacation then investing.

Chris The Original October 22, 2007 at 11:23 am

vidyohs –

Check out the skeptical optimist,, for an interesting take. In real terms, the national debt is actually shrinking. In other words, inflation is eating the value of the debt faster than we're adding new debt.

Don Boudreaux October 22, 2007 at 11:49 am


Given Uncle Sam's gargantuan appetite for wasteful consumption — which I believe IS a problem — the current-account deficit makes the problem less severe than it would otherwise be. If foreigners were not willing to lend to Uncle Sam a used all of the dollars they now lend to him instead to buy U.S. exports, interest rates in the U.S. would be higher than they currently are — and private investment thereby lower.

vidyohs October 22, 2007 at 12:24 pm

Many thanks to
Wojtek Grabski
Chris the original(:-)) I will do that.

Wojtek Grabski October 22, 2007 at 1:46 pm


Forgive me, I don't see the downside. Americans spend a lot, the people from whom they purchase things can't find anywhere to spend the dollars they get where they might retain their value, so they loan them back to Americans, who, they presume, would be most likely to repay with the highest interest. So Americans get to spend again! And the collateral is typically real-estate, which can't leave these shores! Best deal I can imagine — low interest rates, and the worst-case is that the money doesn't get repaid, consumption of foreign goods drops a little, and stuff gets even cheaper through oversupply.

On the flip-side, if you're wrong, and foreigners really are, by reducing interest rates, helping invest in solid, cutting edge, American industry (my take on the situation), then Americans also win through the added investment.

And, your example is a bit flawed. Of all things that a lender would be most afraid of , it would probably be that the borrower spent all the money on a 'vacation' — nothing to repossess! I doubt very much that lending is really that idiotic a business.

spencer October 22, 2007 at 2:38 pm

Don– the federal deficit is the mechanism through which the foreign lending finances consumption rather than investments.

So we are actually in agreement.

Note that in the late 1990s when the US had a capital spending boom the federal surplus plus the foreign capital inflow finance almost half of the capital spending boom.

But since the federal government shifted from surplus to deficit the foreign capital inflow has also shifted from financing investments to finance consumption.

Moreover, this has been accompanied by a sharp drop in capital spending–since 2000 nonresidential fixed investment has fallen from 13% of gdp to 10.5% of gdp — so that even at today's low interest rates we might still be getting crowding out.

Don Boudreaux October 22, 2007 at 3:02 pm

Regardless of how much Uncle Sam borrows and wastefully spends, Americans are better off the greater is the number of people willing to lend to Uncle Sam — and the nationalities of these lenders make no difference. Regardless of their nationalities or their places of residence, more lenders means lower real rates of interest (than would prevail with fewer lenders). And lower real rates of interest mean more private investment than otherwise. This is true even if every cent invested by foreigners in dollar-denominated assets is used only to fund wasteful government borrowing. The reason is that domestic savings that would otherwise have gone to fund this wasteful government borrowing is then freed up for use in productive private markets.

spencer October 22, 2007 at 3:46 pm

But our problem is that we have zero personal savings.

You can not reallocate zero to government.

Don Boudreaux October 22, 2007 at 4:10 pm

If Americans as a group have zero personal savings, that fact does not preclude many individual Americans from having positive personal savings — and, hence, investing those in private markets in America. Nor does it preclude foreigners who do not invest in Uncle Sam's debt from investing in private markets in America.

John Dewey October 22, 2007 at 5:58 pm

spencer: "But our problem is that we have zero personal savings."

Aren't there significant problems with the way personal savings are calculated? For example, consider pensions. When employers make contributions to pension plans, the money is counted as personal income. Capital appreciation increases the value of pension assets, and then payouts are made to retirees. Those payouts – larger than the employer contributions – are counted as consumption. But the capital appreciation is not counted at all in determining the savings rate.

As Tyler Cowen points out, personal investment in education and corporate R&D investment are also considered consumption.

Are we undermeasuring U.S. savings?

Mike fladlien October 22, 2007 at 8:52 pm

It's national saving, not personal saving, that determines the ability of an economy to invest…It's true that personal saving is down, but business saving is averaging around 12% – 14%.

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