Balancing Consumption and Investment as Drivers of Economic Growth

With an eye toward balancing consumption and investment as drivers of economic growth, Prof. Phelps (NYT,8/6/10) calls for a national bank to fund innovation leading to new industries and employment. He argues as follows:

High business investment also depends on companies having confidence in the future. A company might be afraid to invest in research or product lines if it fears the rest of the economy is not doing the same — or if it fears the government might become hostile to its goals. During the Depression, John Maynard Keynes warned President Franklin D. Roosevelt not to damage business confidence with anti-profit rhetoric — to treat titans of business “not as wolves or tigers, but as domestic animals by nature.”

What, then, is to be done? One reform would be to create a First National Bank of Innovation — a state-sponsored network of merchant banks that invest in and lend to innovative projects. Another would be to improve corporate governance by tying executives’ compensation to long-term performance rather than one-year profits, and by linking fund managers’ pay to skill in picking stocks, not in marketing their funds. Exempting start-ups from corporate income tax for a time would also help.

We also need a program of tax credits for companies for employing low-wage workers. That may seem counterintuitive at a time when the Obama administration is pressing education and high-paying jobs, but we need to create jobs at all levels. Early last year, Singapore began giving such credits — worth several billion dollars — and staved off a recession. Unemployment there is around 3 percent.

A revamp of the economy for greater dynamism and inclusion is essential for prosperity and growth. Rather than continuing to argue over solutions to a problem we do not have — low demand — the country needs to focus on fixing the structural problems that, unresolved, will stymie the economy over the long haul.

Edmund S. Phelps, the director of the Center on Capitalism and Society at Columbia University and winner of the 2006 Nobel Prize in Economics, is the author of “Structural Slumps” and “Rewarding Work.”