When you plant a tree in the ground, it grows, producing seeds which become the source of new trees. But remember, trees can only grow where there are resources – water, sunlight and nutrients in the soil.
We can think about government investment in the same way. In a democracy, government spend happens because society chooses to invest in itself. It does this by sprinkling a few seeds into the economy, and if it hits the right spots then the economy will grow. Investing in people, in particular their health and education, tends to pay big time. In technical terms, health and education are areas where the fiscal multiplier is significantly greater than one, as this article shows.
So when the journalists ask, `how are we going to pay for it?’ The answer is, it pays for itself.
Let’s consider a specific example. We have to be careful because every case is different but only by looking at a specific case can we begin to understand how it might work. Suppose, our democratically elected government has a mandate to improve the health service, and in consultation with experts it decides that we need more doctors and nurses. Contrary to what most people think, the problem is not, how are we going to pay for the extra staff? Rather it is where are we going to find them, and what are they no longer doing now that they are doctors and nurses?
Let’s look at the money side first. Just like a bank, government does not need to collect money in order to make a payment. Just like a bank, it can `create’ money by issuing a credit which is balanced by a debt. This debt is cancelled by people paying taxes. However, this does not necessarily mean that to pay the extra doctors and nurses, the government will need to raise taxes. If the economy grows because of the additional investment in health, then tax revenues will rise and cover the extra spend without the need to raise tax rates.
There are limits, of course, and managing the economy is like managing a forest. Just like in the forest, we need water, sun and soil, in the economy we need people with knowledge and skills. We can delve a bit deeper with an even more specific example. Take a nurse called Charlie (could be a Charles or a Charlotte). In the age of austerity, Charlie gave up being a nurse because the hours were long and the pay was bad. Instead Charlie works in a factory making widgets. But work in the widget factory is not great either. Most of the workers are off sick with stress and mental health problems, so when in a new drive to improve health begins, Charlie decides to leave the widget factory and become a nurse again. Charlie is rather good at nursing and helps some old widget colleagues to overcome their problems and return to work. Productivity rises to such as extent that output is increased dramatically. Everyone pays their taxes and all the extra spend on health and more widgets comes back in the form of tax revenue, more than offsetting the extra government spend. Now that’s the magic multiplier effect!
Now you could argue, that the market could do this. The boss at the widget factory should have realised that Charlie would make a brilliant in-work psychologist. Except that it wasn’t happening. The market could not find the solution because the necessary skills and ability – in this case the boss – were not there. Contrary to the Hayekian dictum, the man on the spot does not always know best, sometimes, we need to combine the skills of the collective – private and public – to find solutions.