Review of Keynesian Economics

The political economy of public investment and public finance: challenges for social democratic policies

Jamee K. Moudud * * and Francisco Martinez-Hernandez * *

Keywords: public investment, public finance, state, circuit of capital, effective demand, austerity, social democracy

Abstract

The ‘comprehensive socialization of investment’ was a key policy goal of The General Theory. And yet, empirically, we have seen a decline in the public investment share in most OECD countries since the economic crisis of the 1970s. In this paper we study several issues concerning this decline. First, we draw on a number of different theoretical perspectives, including those of Smith, Marx, and Keynes, to explain the importance of public investment. Second, we show, using an error correction framework, that the levels of net government saving and gross government investment shares are co-integrated. Third, we discuss the various theoretical reasons underpinning this result. Following Kalecki (1943) and Alexander (1948), we argue that the crisis of the 1970s and growing international competition enabled powerful business groups to successfully push for fiscal austerity to increase ‘labor market flexibility,’ a policy framework that has since become the conventional wisdom. Fourth, building on the view that the state is relatively autonomous; Keynes's cautionary observation that the political context shapes business confidence; and Polanyi's argument that social democratic policies always run the risk of appearing to be a threat to private investment, we discuss the challenges to such policies in the current crisis.

Author Notes

The authors would like to thank the two anonymous referees for their helpful comments.

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