Investment Review November 16 – Ben Shenton’s View

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My investment career started in 1978 and has so far spanned 38 years. I think this longevity makes me less susceptible to the optimism that a new political administration brings, but also more cynical which is less helpful. Whilst other economic commentators genuinely believe that infrastructure spending in the USA is a new panacea for US growth I have witnessed the policy before, and watched it fail. For five years the Federal Reserve have been trying to “normalise” interest rates without success, probably because we are now in a new normal of low interest rates which will be the “normal” until globalisation stutters to a halt. The idea that the US economy is suddenly strong enough to take the pain of significant interest rate increases due to a political election result is somewhat bizarre.

Since the elevation of Donald Trump to President the media, and the business community are pushing for a bold federally funded infrastructure stimulus package that they claim will create jobs, raise incomes, and put the economy back on its path of positive economic growth. Related to this sentimental longing for New Deal authenticity is the revival of the teachings of John Maynard Keynes, who postulated in his 1935 The General Theory of Employment, Interest and Money that “There is room…to promote investment and, at the same time, to promote consumption, not merely to the level which with the existing propensity to consume would correspond to the increased investment, but to a higher level still.” Subsequent generations of elected officials throughout the world took this observation as a license to raid their treasuries, and no country could be sorrier for endorsing a primitive version of Keynes’s teachings than the Japanese–who squandered vast sums of national wealth in a vain attempt at stimulus that cost them the chance to lead the world in economic growth and prosperity.

Research by The Heritage Foundation has concluded that past infrastructure spending–especially related to transportation–has little to show in terms of counter-cyclical stimulus or job creation. Much of this lack-lustre impact stems from the long lag time involved in getting such spending pro¬grams up and running, as well as the propensity of the state and local governments to substitute federal money for already-committed state and local money in order to shift such funds to other purposes. In 2012 President Obama implemented such a scheme on a smaller scale than that currently proposed. The politicians hailed the fact that the spending would be ‘timely’ – promising that many projects would commence within 9 months. Of course, this is a ludicrous time frame for infrastructure spending from scratch and this demonstrated that all the initiative did was move the funding of many projects, which were planned to commence anyway, from State funding to Federal funding.

Japan provides significant guidance in both infrastructure spending and the actual long term path of interest rates – and by observing the travails of the Japanese economy for the past twenty years our clients have fully benefited from the bull market in bonds. I remember Japan entering the deflationary low interest spiral that has suffocated their economy. Western economists were full of Keynesian advice and their reliance on bold infrastructure spending in the early 1990s led to the squandering of so much money on so many wasteful projects that the country soon slipped from one the world’s most prosperous nations to the status of a middling also-ran that has yet to recover from its mistake.

Japanese fiscal policy during the 1990s was flamboyantly unrestrained, and during that decade no other advanced industrialized country had expanded government spending by nearly as much. Starting in 1991, government spending (outlays) in Japan accounted for just 31.6 percent of the nation’s GDP–one of the lowest among members of the Organisation for Economic Co-operation and Development (OECD). That year also marked the high watermark of Japanese prosperity: In 1991, Japan’s per capita gross national income (as adjusted for purchasing power parity) reached 86 percent of the U.S. gross national per capita income, compared to the 66 percent Japan had reached in 1970–a remarkable achievement.

As the decade of the 1990s wore on, many other countries–especially in Europe–were paring back government spending to spur growth, but Japan was doing just the opposite. By 2000, its government outlays had jumped to 38.3 percent of GDP, while Canada had reduced its government’s share from 52.3 percent in 1991 to 41.1 percent, and the United Kingdom had gone from 44 percent to 37.5 percent, to cite just a few of the many developed nations that were actively shrinking government over that period to bolster their private sectors.
Beginning in 1991-1992, Japan adopted the spending approach now advocated by many in the Trump administration when it embarked on a massive nationwide program of infrastructure investment. Between 1992 and 2000, Japan implemented 10 separate spending stimulus packages in which public infra¬structure investment was a major component.

The relative prosperity of the Japanese has been on the decline as government spending has advanced. After peaking at 86 percent of U.S. income in 1991 and 1992, Japanese income continually fell behind the U.S., and by 2000, Japan’s per capita gross national income had fallen to 73.7 percent of that of the U.S. despite the increased spending stimulus in Japan during the 1990s and into the 2000s. In 1991 only the United States, Austria, and Switzerland had higher per cap¬ita incomes than Japan. Today there are 27 countries ahead of Japan.

Although the benefits of a costly, infrastructure-focused stimulus package based on massive government spending may be intuitively attractive, past evidence suggests the impact of government spending programs intended to encourage economic growth is very modest and unlikely to enhance recovery or deter recession. As noted above, the Japanese government implemented such a program during the 1990s, and the consequence was two decades of economic stagnation. Less ambitious infrastructure stimulus pro¬grams have been implemented in the United States over the past few decades, and numerous independent and government studies have concluded that these programs had little impact on economic activity or jobs.

It is important to recognise that infrastructure and the continued investment in it are important underpinnings of future economic growth and sustained prosperity. But it is equally important to recognize that the long-term nature of these benefits to cost-effective mobility and quality services, and the need to choose carefully among competing options and technologies, suggests that a stimulus scheme based on spending is ill-suited to the short-term stimulus needs that are of concern to policy¬makers. Given current congressional practices, any stimulus package approved by Congress is certain to contain a host of projects that have nothing to do with prosperity and everything to do with political influence and current fashion.

When the Japanese infrastructure spending policies failed to lift economic growth, interest rates, nor inflation the Western Economists blamed Japan’s method of implementation rather than the policies themselves. No doubt similar excuses will be used when they fail the Trump administration.

Ben Shenton Chartered FCSI