The Market Demand for Government Investment

In my previous article on the bloated private sector, I failed to adequately explain my main point.

For the past 3 decades faith in the free market powers of the private sector have led to a massive misallocation of resources away from public sector investment. A careful reading of price signals reveal a severe under investment in public goods relative to private sector goods. I would further argue that the unstable bubbly nature of financial markets is the result of excessive capital being allocated to the narrow range of goods and services in which the market works well.

The following contrasting sets of investments opportunities demonstrate how the private sector has become bloated while the public sector has been starved of necessary resources.

Public Education vs. Information Technology

The development and rapid proliferation technologies such as the internet, cell phones and other communication tools has brought undeniable benefits. But is the market calling for more resources to be dedicated to these industries. Not really. Over the past couple of decades, the price of computing power and communication technologies has been in nearly continuous free fall. New innovations quickly become commodities while many of the best and most popular innovations from Youtube to Facebook have failed to find a revenue stream.

If some of the investment in IT has been misplaced, what would be a better use of the bright mathematically inclined minds. Over the long run, human capital is the limiting factor in innovation and growth. The wage differential between educated and uneducated workers is a clear price signal indicating demand for education. Yet we have ignored this rapidly rising price signal by failing to provide adequate support to schools at all levels. The rapidly rising tuitions at public universities is another indicator of declining public support for education at precisely the time when this sort of investment is most needed.

Public Health vs. Processed food

Public health spending is one of the ultimate public goods as it benefits the society as a whole. There is no doubt that American’s spend a lot on healthcare, more per capita than any other country. Yet our health outcomes are hardly impressive. Investing a little more in creating an environment that promotes health could save far more in future healthcare and lost productivity due to preventable disease. From teaching basic nutrition principles to providing safe places for people to be physically active to preventing outbreaks of food borne illnesses our public health efforts have been pathetic due to a lack of commitment.

While, we have barely attempted to create a healthy environment, the food industry has had no trouble bringing new food like substances to market. Given this failure it is not surprising that today’s young people may be the first generation in American history that fails to outlive their parents.

Urban Infrastructure vs. Suburban housing

The housing collapse of the last couple of years makes the misallocation of resources in the housing sector abundantly clear. Yet the market has been sending out the same signals for years. Developers always justified suburban car based residential development as providing what the market. Yet a simple look at price data tells a different story. Real estate prices in walkable urban areas have consistently been far higher than in suburban car oriented areas. In the current crises real estate markets in places like Manhattan, DC and San Francisco have held up far better than the rest of the country.

Yet it would be impossible for private developers to recreate high quality urban environments. These places require significant investment in transit, law enforcement, parks and other amenities that require government support. Without public investment private developers could only create a limited range of housing options. Hence the appreciation of urban real estate prices relative to suburban areas.

The market is incapable of providing the full range of investments needed to maintain a healthy growing society. If we come out of the current economic crises with a more balanced distribution between public and private investment we will be in a better position to maintain long term growth.

2 comments to The Market Demand for Government Investment

  • Raymond


    The government does not produce anything and what money it has comes from borrowing or taxing us.

    We need to clarify what is funded by what here.

    Since there is no coercion to buy anything in the market, goods and services that are bought are things people actually need or want. Every person allocates his or her own money according to their priorities. So collectively, consumers drive the market with their changing buying decisions since no businessman want to produce anything no one would buy. Failure to adapt means liquidation (except for today’s bailout regime).

    Roads, bridges, public schools and others you call “public goods” are paid for with taxes and borrowed money from citizens. Allocated by various government bodies,
    and guided by political priorities.

    Both sides can mis allocate.

  • dvb


    All of the points that you make are true, but I don’t think you fully understand my argument.

    I agree that government cannot create production out of thin air. Investment in public goods obviously comes at the expense of private investment. And I agree that goods and services that are bought in the free market represent things that people genuinely want.

    However, the free market is only effective at producing a certain range of goods and services. People want ipods and cheeseburgers, but they also want clean air, parks and safe streets. The market is incapable of determining the how to allocate resources between these two classes of goods.

    The general point that I am arguing is that overall the economy has been investing too heavily in the private sector, while neglecting public investment that would have a higher marginal value. I think careful analysis of relative price trends would show many instances in which markets actually show a strong preference for increased government investment.

    I admit that more research needs to be done to test this hypothesis, but I think that compelling evidence exists.

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