Should Government Spend or Invest Money?

In order to ensure long-term economic prosperity, states and localities should focus on investment.
November 2011
William Fulton
By William Fulton  |  Columnist
William is a Governing columnist, director of the Kinder Institute for Urban Research at Rice University and former mayor of Ventura, Calif.

There’s a big debate these days about whether the government simply spends money or invests it. Republicans tend to say the government spends money, which is presumably bad for the economy, while Democrats tend to say the government invests money, which is presumably good for the economy.

If only it were that simple. In truth, the government sometimes just spends money -- which can be good in the short term and bad in the long term. And then sometimes the government invests it -- although the investments don’t always pay off.

So, in bad times like these, what should the government do? In particular, what, if anything, can state and local governments do? Will spending or investment make any difference to the economy in the short run? How about the long run?

Let’s begin with the difference between spending and investment. In our personal lives, spending is surrendering money now in order to get some good or service in return. Investing is surrendering money now with the hope of getting a financial return later on, and winding up with more money in the end.

A short-term economic stimulus is clearly about spending. The government spends money to put money in the pockets of consumers who in turn spend it. This is what Franklin Delano Roosevelt did during the Great Depression, and it is what Barack Obama did in 2009. There may be some long-term benefit -- think about the New Deal-era bridges you drive across -- but that’s not the intent. The intent is to stimulate spending now. The downside is that the government may have to incur long-term debt for short-term benefit.

At the same time, the government does invest money all the time, in all kinds of things -- bridges and highways, medical and high-tech research, training and education. These investments cut across all agencies and all levels of government, and they all have a demonstrable long-term payoff. A good transportation system facilitates the movement of goods and services. Basic research helps lay the foundation for new commercial products. Training and education ensures that the workforce has the skills required to get and keep jobs. There’s a short-term benefit to all these investments -- construction jobs, for example -- but that’s not the intent. The intent is to lay a solid foundation for long-term economic growth. The downside is that the payoff can be years or even decades away.

So what should the government do? Spend? Invest? Or both?

I think the answer -- especially at the state and local level -- is that government has to focus on investment rather than spending in order to ensure long-term and stable economic prosperity.

The question of whether the government should engage in short-term spending to stimulate the economy will always be controversial. For every economist who tells you that the Obama stimulus kept the bottom from falling out of the economy, there’s another saying that Obama’s debt is a drag on it. After all, 80 years after the fact, economists are still arguing whether the New Deal saved the economy or wrecked it.

In a downturn, there’s tremendous pressure on everybody in the political system -- not only the president, but also every governor, legislator and mayor -- to perform some kind of economic miracle. The truth of the matter, though, is that governors and mayors can’t do much to turn around a short-term economic crisis.

Only the federal government is big enough, and has enough control over the money supply, to influence overall consumer behavior in the short term. Even in huge states like California, New York and Texas, government spending isn’t going to fluctuate much from year to year -- and when spending does go up a lot, it’s usually because those states are engaged in long-term capital projects backed by bond issues. In other words, classic investment-style government spending.

So the best thing state and local governments can do is to devise a sound, long-term strategy of investment in infrastructure, education, research and economic development, and stick to it. This isn’t easy even in good times, because there is always pressure to divert the funds to short-term or politically popular purposes. How many times, for example, have you seen a state or big city use bond proceeds to fund day-to-day operations? In bad times, of course, it’s tempting to view medical research or specialized job training as a frill we can’t afford.

But look at the cities that have survived the economic downturn rather well: Austin, Salt Lake City, San Diego and San Francisco. They’re not places that make desperate moves when the economy declines. Nor are they all places with low taxes and low regulation, though some of them are. Rather they’re places that have laid down long-term public and private investments in infrastructure, education and research -- and, frankly, have effectively leveraged Washington’s consistent long-term investments in these arenas.

If you’re in tough shape today, there may not be much you can do as a mayor or governor to fix problems right now. But clearly the best strategy to deal with short-term downturns in the future is to make long-term investments now, and consistently over time.