Perhaps the most important topic in economics is the determinants of sustained growth for an economy. The arithmetic of compound interest tells us that even a small addition to the annual economic growth rate creates huge improvements in living standards for subsequent generations.

Economists have been investigating the determinants of economic growth for decades, and conclude that investment is crucial for an economy to grow. High rates of investment in the present make possible future consumer spending. The debate continues as to the type of investment that is most important, and whether specific types of investment might be counterproductive (think of Stalin’s five-year plans).

A number of economists have emphasized physical investment: that is, the accumulation of structures, business plant and equipment and other tangible assets. J. Bradford De Long and Lawrence H. Summers found that “machinery and equipment investment has a strong association with growth,” adding that it was “much stronger than found between growth and any of the other components of investment.” (see also this paper in The Quarterly Journal of Economics by N. Gregory Mankiw, David Romer and David N. Weil)

Other economists, including Theodore Schultz and Gary Becker, have emphasized the accumulation of human capital through schooling and other kinds of training and learning. Arguably even machinery and equipment investment is not possible or effective unless the work force is skilled enough to install and use the new equipment.

A third school of thought points to investment in ideas and new technologies that outlast their inventors (the economist Paul Romer has made some major contributions here). This approach tends to be pro-population and pro-city, because ideas and technologies have economies of scale.

Economists are also unsure about the public policies that might promote investment. Should college educations get heavy subsidies? Should government enterprises be doing the basic research? Should tax rates on capital income be low? Should the financial industry be regulated?

But we do largely agree that investment, rather than consumer spending, is the means to achieving the high growth. High growth can sustain consumer spending in the future.

That’s why I was startled to see my fellow Economix blogger Jared Bernstein assert exactly the opposite. In supporting President Obama’s economics speech, Mr. Bernstein (who served in the Obama administration) contends that buying power for the middle class is essential for economic growth, because those people have a high “marginal propensity to consume” rather than invest and save.

I can see how supporting the middle class might enhance growth by helping parents afford to educate their children or altering the political climate in a way that better supported pro-investment policies. Or maybe now is the time for temporary stimulus rather than pro-growth policies. But that’s not what Mr. Bernstein wrote. He contended that, according to “solid theory,” middle-class “buying power” is critical for growth because the middle class is a segment of society that is unlikely to put its income toward saving and investment.

Mr. Bernstein has growth theory backward. But just in case he and President Obama have been following the latest economic growth theory more closely than I have, I went back to check the economic growth textbooks. My favorite was written by Robert Barro and Xavier Sala-i-Martin; I also looked at the latest editions of three books recommended by Tyler Cowen of George Mason University.

All of the books look closely at investment. All of them note the three flavors of investments: physical, human and ideas. None of them say that a high marginal propensity to consume might be a way to create sustained economic growth. None of them even has an entry in its index for “marginal propensity to consume” or any related concept (Professors Barro and Sala-i-Martin note that consumption is a function of wealth, and in doing so they show how investment rather than consumption leads to economic growth).

Mr. Bernstein emphasizes that “consumer spending as a share of gross domestic product in the United States is about 70 percent,” but that’s a red herring, because the models of investment and growth also assume the same fact. Economists understand that measuring the largest component of aggregate spending does not tell us whether growth is created by investment or consumer spending.

Philippe Aghion’s and Peter Howitt’s textbook has an extensive treatment of public policies that might promote economic growth, yet neither this nor the others mentioned above include Mr. Bernstein’s recommendation of shifting resources to persons with a high propensity to consume. Instead, the Aghion-Howitt book discusses “fostering competition and entry,” “investing in education,” “reducing volatility and risk,” “liberalizing trade,” “preserving the environment” and “promoting democracy.” (The authors do not necessarily conclude that each of these policies is a good idea, but merely explain how economic theory might link the policies to growth.)

Economic growth begins with investment and ends with consumer spending. Not the other way around. To the degree that policy makers are confused on this point, it should be no surprise that they are delivering low economic growth rates.


Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy”