In a series of articles and books, John Walker and Harold Vatter attempted to make the case that the U.S. economy suffers from chronically insufficient demand that leads to growth below capacity. Of particular interest is a 1989 Journal of Post Keynesian Economics (JPKE) article that extends Domar's work on the supply side effects of investment spending as well as a 1997 book that provides a comprehensive analysis of the evolution of the U.S. "mixed" economy. In addition, they published several articles of interest in the Journal of Economic Issues (JEI) that dealt with problems of secular stagnation (Vatter and Walker 1982; 1983; Vatter, Walker and Alperovitz 1995). Their analysis of secular growth complements the well-known writings of Hyman Minsky, who also emphasized the role of the "big government" and the "big bank" in stabilizing an unstable economy over the cycle. Like Minsky, Vatter and Walker argued that U.S. capitalism has evolved through several distinct forms, although they characterize the last one hundred years as a period of secular stagnation. This article will summarize, provide support for, and use the Vatter and Walker approach to examine some of the dangers facing the U.S. economy today. As appropriate, the ideas of Minsky will be used to supplement the argument.
A Summary of Vatter and Walker's Main Theses
In The General Theory, Keynes (1964) had addressed the demand-side effects of investment: rising investment generates income that in turn induces consumption spending. Keynes singled out investment as the major "autonomous" component of spending, as it is focused on future sales and expected profits over the life of the plant and equipment. Hence, fluctuations of investment "drive" the economy. Because
Keynes was most interested in explaining the determination of aggregate output and employment at a point in time, he tended to hold the productive capacity of the economy constant. Whether the economy was operating at full capacity or with substantial excess capacity could then be attributed to the level of effective demand, itself a function of the quantity of investment.
Keynes argued that the capitalist economy will tend to operate below full capacity both in the short run as well as in the long run. For any given level of spending a demand gap is generated because the marginal propensity to consume is less than one; this gap must be filled by spending that is not (mostly) a function of income. In a small, closed economy, autonomous investment is the main type of spending that fulfills this role. The problem is that as income grows, the demand gap increases because the marginal propensity to consume tends to fall. Further, the inducement to invest also tends to fall at higher levels of investment for a variety of reasons. For example, the supply price of investment rises due to bottlenecks and rising costs in the investment goods industries, while prospective profitability (or marginal efficiency) of investment goods tends to fall due to congestion of the market (growing capacity to produce depresses marketability of output). For this reason, the economy reaches equilibrium at less than full employment.
When the economy operates below full capacity, the traditional solution would be to raise effective demand--either by encouraging more investment, or by increasing one of the other components of demand. After WWII, "Keynesian policy" came to be identified with "fine-tuning" of effective demand, accomplished through various investment incentives (tax credits, government-financed research and development, countercyclical management of interest rates) and countercyclical fiscal policy. In practice, policy tended to favor inducements to invest over discretionary use of the federal budget--indeed, "more investment" has been the proposed solution to slow growth, high unemployment, low productivity growth, and other perceived social and economic ills for the entire post-war period (Wray 1994-1995).
However, Domar had already recognized the problem with such a policy bias at the very beginning of the post-war period. When we turn to the subject of economic growth, it is not legitimate to ignore capacity effects as investment proceeds. Not only does investment add to aggregate demand, but it also increases potential aggregate supply by adding plant and equipment that increases capacity. To be more precise, a portion of gross investment is used to replace capital that is taken out of service (either because it has physically deteriorated, or because of technological obsolescence), while "net investment" adds to productive capacity. Further, note that while it takes an increase of investment to raise aggregate demand (through the multiplier), a constant level of net investment will continually increase potential aggregate supply. The "Domar problem" results because there is no guarantee that the additional demand created by an increase of investment will absorb the additional capacity created by net investment. Indeed, if net investment is constant, and if this adds to capacity at a constant rate, it is extremely unlikely that aggregate demand will grow fast enough to keep capital fully utilized. This refutes Say's Law, since the enhanced ability to supply output would not be met by sufficient demand. As such, "more investment" would not be a reliable solution to a situation in which demand were already insufficient to allow full utilization of existing capacity.
Vatter and Walker (1989) carried this a step further, showing that after WWII, the output-to-capital ratio was at least one-third higher than it had been before the war. Due to capital-saving technological innovations, it takes less fixed capital per unit of output so that the supply-side effects of investment will persistently outpace the demand-side multiplier effects (for example, as a constant level of net investment adds to capacity at a rising rate). The only way to use the extra capacity generated by net investment is to increase other types of demand. These would consist of household spending (on consumption goods as well as residential "investment"), government spending (federal, state, and local levels), and foreign spending (net exports). For reasons to be explained below, Vatter and Walker believed that growth of government spending would normally be required to absorb the capacity created by private investment. Indeed, they frequently insisted that government spending would have to grow at a pace that exceeds GDP growth in order to avoid stagnation (Vatter and Walker 1983; 1989; 1997; Vatter, Walker and Alperovitz 1995).
This should not be interpreted as an endorsement of "Keynesian" "pump-priming" to "fine-tune" the economy. Indeed, Hansen had previously demonstrated that pump-priming would fail (Vatter and Walker 1997, 147). If government increases its spending and employment in recession, raising aggregate demand and thus economic activity, only to withdraw the stimulus when expansion gets underway, this will simply take away the jobs that had been created, restoring a situation of excess capacity. The larger the government, the harder it becomes to cut back spending because jobs, consumption, income, and even investment all depend on government spending. According to Vatter and Walker, in a well-run fiscal system, government spending will rise rapidly when investment is rising (to absorb the created capacity), and then will still rise rapidly when investment falls (to prevent effective demand from collapsing). They call this a "ratchet"--rather than countercyclical swings of government spending, "government as a share of the economy should rise indefinitely" (Vatter and Walker 1997, 170). Adolf Wagner had argued that economic development leads to industrialization and urbanization, which generates an absolute increase as well as a relative increase in the demand for more government services. (Of course, J.K. Galbraith made a similar point.) Hence, for political and socio-economic reasons, government should grow faster than the economy. If it does not, not only will this leave society with fewer publicly provided services than desired, but it will also generate stagnation through the Domar problem.
These arguments concerning secular trends can be supplemented by the Kalecki/Minsky analysis of the role of government over the cycle. Aggregate profits are equal to investment, plus the government deficit, plus the current account surplus, plus consumption out of profit, and less saving out of wages. When investment falls, profits fall. As Minsky (1986; 1993) put it, past investment undertaken on the expectation of future profits cannot be validated at the lower level of investment, depressing current investment and further lowering profits through a process of cumulative causation. In a big government economy with a budget that automatically swings in a counter-cyclical manner, deficits are created that attenuate effects on profits. Capital-saving innovations increase the capacity effects of investment, thus, so long as investment remains above replacement levels, potential aggregate supply rises. To utilize this new capacity, aggregate demand must increase even though investment has fallen to a lower level. Unless another source of demand fills the gap, the government's budget must become more stimulative. This is more easily accomplished with a bigger government because of the larger potential swings of its budget balance relative to the size of the economy as a whole. Minsky argued that government must be at least as large as investment, however, government will have to be larger to the extent that investment swings are large and if automatic swings of the budget are too small to offset the demand effects of cyclical swings of investment. Further, as discussed below, persistent trade deficits will increase the role of government in maintaining profits and demand by offsetting the leakage to imports.