Report No.: GAO/OCG-93-2TR Date: December 1992
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Author: United States General Accounting Office
Office of the Comptroller General
Addressee: Transition Series
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CONTENTS
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Letter
The Importance of Investment
Lagging Investment and Growth in Productivity
Changing Federal Policy to Increase National Investment
- Reducing the Long-Run Deficit Critical to Increasing Investment
- Reorienting Federal Policies to Focus on Investment
Structuring the Budget to Emphasize Investment
Choosing Among Competing Investments
- Investing in Infrastructure
- Investing in Human Capital
- Investing in Research and Development
Conclusion
Related GAO Products
- Budget Policy
- Investing in Infrastructure
- Investing in Human Capital
- Investing in Research and Development
Transition Series
Figures
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Figure 1: Gross Fixed Capital Formation
Figure 2: Comparison of Growth Rates of Several Measures of Economic
Performance
Figure 3: Effect of the Federal Budget Deficit on Net National Savings
(1960-90)
Figure 4: Outlays for Federal Investment, Health, and Net Interest (1962-91)
Office of the Comptroller General
Washington, DC 20548
December 1992
The Speaker of the House of Representatives
The Majority Leader of the Senate
In response to your request, this transition series report discusses a topic
critical to our nation's long-term economic future--the need to increase
investment, both public and private. Investment is important because it
increases the economy's long-term productive capacity.
Within an overall fiscal policy emphasizing deficit reduction, federal
priorities should shift toward investment and away from consumption.
Structuring the budget to emphasize well-chosen investment would help to
support this shift.
The GAO products addressing related issues are listed at the end of this
report.
We are also sending copies of this report to the President-elect, the
Republican leadership of the Congress, the appropriate congressional
committees, and the designated heads of the appropriate agencies.
THE IMPORTANCE OF INVESTMENT
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Long-term economic growth is central to almost all our major concerns as a
society. During the last two decades, growth in U.S. productivity has slowed
substantially. Without improved productivity and increased growth, the nation
cannot continue to expect an ever-improving standard of living for future
generations.
Healthy economic growth depends on many things, but private and public
investment in infrastructure, human capital, and technology are essential.
Private investment can buy more and better equipment, enhance production
processes, stimulate the development of new products and services, and support
training to improve job skills--key ingredients required to improve
productivity and the long-term productive capacity of the economy. Public
investment policies both foster increased private investment and help provide
the infrastructure, the education and training, and the technological advances
that markets alone cannot provide.
Economic policy in general addresses two distinguishable issues: (1) the
health of the economy today and (2) the productive capacity of the economy in
the future. Fiscal stimulus, designed to focus on the first issue, seeks to
use existing but unused economic resources to improve the short-term cyclical
health of the economy. A successful fiscal stimulus program could help to
bring the economy to its full potential in the short term. In contrast, the
interest in investment programs lies in their ability to increase the
long-term productive capacity of the economy.
The economy will need additional productive capacity in the next century. By
the year 2020, the United States will have undergone a large demographic
shift. Most of the baby boom generation will have retired, and a relatively
smaller working population will have to support this large number of retirees.
Because investment takes time to bear fruit, the nation must invest now to
ensure the long-term growth needed to support these retirees without causing a
decline in workers' living standards.
LAGGING INVESTMENT AND GROWTH IN PRODUCTIVITY
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U.S. investment stands at its lowest level in three decades. [ Footnote 1:
There are several ways to measure investment. To permit use of historical
trend and cross-country comparative data, GAO uses the United Nations' System
of National Accounts (SNA) definition in this section. Although this measure
does not include education and training or research and development spending
in its definition of investment, as GAO does, it nonetheless reflects an
economy's relative commitment to investment. ] Since 1960, total gross U.S.
fixed capital investment, public and private, has ranged between 17 and 20
percent of Gross Domestic Product (GDP). Until 1989, it never dropped below 17
percent. Since 1985, however, it has declined steadily, to an unprecedented
low of 16 percent of GDP in 1990. Furthermore, net investment has declined
even more sharply--from an average of 9.8 percent of the economy in the 1960s
to an average of 6.0 percent in the 1980s. [ Footnote 2: Net investment is
gross investment minus depreciation. Net investment measures the increase in
the capital stock from year to year. ]
These trends alone would be cause for concern. In addition, however, other
countries have far surpassed the United States in their commitment to
investment. According to the Organization for Economic Cooperation and
Development (OECD), Japan in 1990 invested 33 percent of its GDP in gross
fixed capital--more than twice as much as the United States. Other major U.S.
trading partners also have significantly higher levels of investment: France,
Germany, and Canada invest over 21 percent of GDP. In 1990, the United States
ranked last in gross fixed capital formation not only among the 7 largest
industrialized nations but also among the 24 OECD member countries.
As figure 1 shows, this gap has widened since 1985. While the other major
industrialized countries of the OECD have, on average, been increasing fixed
capital investment, the United States has slowed its investment spending.
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Figure 1: Gross Fixed Capital Formation
The following table represents the data for this chart in the printed version
of the report. The actual figure appears in the printed report.
(Gross fixed capital formation as a percent of GDP)
Average of 7
other largest
Year United States OECD countries
---- ------------- --------------
1985 18.12 20.63
1986 17.80 20.48
1987 17.28 21.05
1988 17.07 21.89
1989 16.64 22.55
1990 16.11 22.62
The U.S. economy is already paying a price for this slowdown. Figure 2
compares growth since 1973 to growth during 1948-73 in three measures of
economic well-being: real GDP per capita, real disposable income per capita,
and real compensation per capita. These measures illustrate the slowdown of
the postwar boom in the U.S. standard of living since 1973.
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Figure 2: Comparison of Growth Rates of Several Measures of Economic
Performance
The following table represents the data for this chart in the printed version
of the report. The actual figure appears in the printed report.
Average annual percentage change
1948-73 1973-89
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Real GDP per capita 2.00 1.55
Real dispoable income 2.37 1.69
per capita
Real compensation per 2.94 0.73
hour
Source: Committee for Economic Development.
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In addition, an analysis by the Committee for Economic Development suggests
that if the savings rates of the 1980s had stayed at the pre-1980s levels, the
nation's potential GDP would have been $300 billion higher by 1990. [ Footnote
3: _Restoring Prosperity: Budget Choices for Economic Growth_, Committee for
Economic Development (1992). ]
CHANGING FEDERAL POLICY TO INCREASE NATIONAL INVESTMENT
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The federal government influences investment by others--state and local
governments and the private sector--and engages directly in investment itself.
In both of these fundamental areas, the federal government's impact in the
last decade has been increasingly unfavorable. The growing federal budget
deficit has absorbed savings that would otherwise be available to finance
investment, either public or private, and the share of federal spending
devoted to public investment programs has declined.
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REDUCING THE LONG-RUN DEFICIT CRITICAL TO INCREASING INVESTMENT
The budget deficit exerts the single most important federal influence on
investment today. Private investment must be financed from domestic savings or
capital from abroad. As the federal deficit has grown, the share of national
savings available for private or state and local investment has fallen. Figure
3 shows the combined effect of a declining savings rate and a growing deficit.
The share of net national product available for new capital formation declined
from about 9 percent in the 1960s to just over 2 percent in 1990.
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Figure 3: Effect of the Federal Budget Deficit on Net National Savings
(1960-90)
The following table represents the data for this chart in the printed version
of the report. The actual figure appears in the printed report.
(Percent of Net National Product)
Savings Available Savings Absorbed
for New Capital by the Budget
Formation Deficit
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1960-69 8.8 0.2
1970-79 7.9 1.9
1980-89 4.4 4.0
1990 2.3 3.4
Source: _Economic Report of the President_ (Feb. 1992).
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In the 1980s, inflows of foreign capital kept U.S. investment higher than the
available domestic savings would otherwise have permitted, but this foreign
investment has some cost--the United States must ultimately pay dividends or
interest to the foreign owners of the assets involved. There is no guarantee
that foreign capital can continue to flow in at these levels, especially if we
fail to reduce the deficit.
The surest way to increase investment in the United States is to increase
national savings. And the surest way to increase national savings is to reduce
federal dissaving--that is, to reduce the deficit. We have argued that
pursuing a fiscal policy path that achieves a budget surplus by early in the
next century offers the most promise for boosting savings and long-term
growth. Following such a path could increase real GNP in the year 2020 by
almost 10 percent--in contrast to "muddling through" with deficits of 3
percent of Gross National Product (GNP). [ Footnote 4: See _Budget Policy:
Prompt Action Necessary to Avert Long-Term Damage to the Economy_
(GAO/OCG-92-2, June 1992). See also _Budget Issues_ (GAO/OCG-93-1TR, Dec.
1992), another transition series report. ]
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REORIENTING FEDERAL POLICIES TO FOCUS ON INVESTMENT
Long-term deficit reduction is a vital element of a federal investment
strategy. It can be complemented, however, by other federal policies and
programs that encourage private investment and/or programs that support
efficient public infrastructure, an educated work force, and expanded
technology innovation. In the past, the federal government--through its
investments in physical capital, human capital, and research and development;
its tax policies; [ Footnote 5: Investment tax credits (ITC) historically
have constituted an important dimension of federal economic policy and are
under discussion at this writing. Economists generally agree that a
time-limited ITC creates incentive to move investment forward and hence should
exert a positive short-term (stimulative) effect on the economy's cyclical
health. There is less agreement regarding the long-term economic effects of an
ITC. ] and its regulations--has played an important role in providing an
environment conducive to growth.
However, recent trends raise concerns. The growing portion of the budget
absorbed by interest payments and consumption programs, particularly health,
has squeezed the discretionary sector of the budget, which funds federal
investment programs. Figure 4 shows trends in federal outlays for investment
as a share of GNP. Between 1980 and 1984, total federal outlays for investment
programs declined as a share of GNP. During the 1980s, the federal share of
GNP for public investment was eclipsed both by federal health spending and by
net interest payments on the debt.
Given the size of the deficit and the need to reduce it, however, decisions on
the future levels of the deficit should be made independently of decisions on
the amount of federal spending for investment. It would be unfortunate if, in
the process of cutting the deficit to increase private investment, the
government reduced effective federal investment programs. Therefore, within an
overall fiscal policy emphasizing deficit reduction, priorities should shift
toward well-chosen federal investment programs. Although the rates of returns
of these programs are often difficult to measure, investment programs are more
likely to improve long-term growth than many federal consumption programs. As
we point out in our transition series report, _Budget Issues_ (GAO/OCG-93-1TR,
Dec. 1992), containing explosive health care costs is an essential part of
such a shift.
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Figure 4: Outlays for Federal Investment, Health, and Net Interest (1962-91)
The following table represents the data for this chart in the printed version
of the report. The actual figure appears in the printed report.
STRUCTURING THE BUDGET TO EMPHASIZE INVESTMENT
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Recent trends in the investment share of the budget are not the result of an
explicit strategy or set of national priorities. They represent instead the
accumulated results of a large number of individual budget decisions regarding
dozens of programs. The budget is currently not structured to facilitate a
shift in the composition of spending between investment and consumption.
Because the budget treats all expenditures alike, it obscures the long-term
investment character of some federal activities. These activities, unlike
spending for current consumption, produce assets that can generate future
benefits to the economy as a whole. Differences between investment and
consumption activities should be taken into account in allocating federal
resources.
Federal tax subsidies and regulations can also promote federal investment
goals. Tax expenditures represent a major tool for influencing economic
activity and should be considered in concert with investment spending
decisions. The present budget process, however, does not encourage
decisionmakers to consider these other tools along with spending decisions.
The creation of an investment category within the overall unified budget would
provide a framework for developing, displaying, and analyzing the information
needed for policymakers to consider the investment effects of budget
decisions. It would also create a vehicle that could be used to structure the
process of making decisions about the allocation of investment resources. Tax
expenditures supporting investment could also be displayed within such an
investment category to provide a more complete picture of federal resources
devoted to investment.
Establishing "investment" as a budget category will raise definitional issues.
Care must be taken to prevent stretching the term to cover a host of programs
with only remote effects on long-term economic growth. As noted above, we
apply the term investment only to those initiatives, programs, or activities
that seem likely to increase the productive capacity of the economy.
Innovations in technology, better education and training, and improvements in
infrastructure all help to increase workers' productivity, thereby raising the
productive capacity of the economy and permitting continued improvement in our
standard of living.
This definition of investment differs from those in traditional capital
budgets. It includes spending to improve human capital, to support research
and development, and to fund some public physical capital. But it excludes
spending on noninvestment capital, such as federal office buildings and
weapons systems. Such expenditures may improve the efficiency of government
agencies' operations and create jobs in the short term in particular regions
of the country; but they do not improve the long-term productive capacity of
the economy.
CHOOSING AMONG COMPETING INVESTMENTS
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Increasing the visibility of investment programs in the budget is important to
attaining the larger objective of promoting investment within limited federal
resources. This means choosing among competing investment strategies and
programs so that federal resources can be used in ways that will most
effectively promote long-term economic growth.
Ideally, policymakers would have access to measures of relative rates of
return from federal investment programs as a basis for deciding how to
allocate resources. However, such data are scarce. Additional research is
needed to develop more and better information for estimating the economic
effects of various types of public investment. A program found to have minimal
impact on private economic growth can then be either evaluated against other
criteria or phased out in favor of other strategies.
Although we know relatively little about the economic impact of different
investments, a few well-considered questions may be helpful in roughly
assessing competing investments' relative worth.
-- _First, is it really an investment?_ In other words, does it seem likely to
increase the economy's long-term productive capacity? Does the growth
represent an addition to total GDP or is it simply a shift from one
geographic region or economic sector to another? What evidence supports
this investment's link to economic growth?
-- _Second, how good an investment is it?_ How much growth might it generate,
and over what period of time? Does it address a recognized national
problem? How do the potential benefits compare to the costs, and is this
investment the best, most cost-effective approach to solving the problem?
Why hasn't the private sector already made this investment? Must other
actions be taken--or money spent--for this investment to succeed?
-- _Third, is the investment program well designed?_ Does it employ the most
effective federal policy tools? What other policy approaches are currently
in place, and are they duplicative or even conflicting? That is, would a
change in pricing, tax policy, or regulation be more effective than federal
outlays? Is the program targeted to produce maximum benefit? Is it designed
to support or leverage rather than replace private or state and local funds
for this purpose? Does the program include provisions to assess its
effectiveness?
Although considering these questions can help focus decision-making, judgment
rather than well-documented data will in most instances guide answers.
Information on the effects of specific investments on economic growth is
limited. Nonetheless, some data are available to assist decisionmakers in
identifying attributes of investments.
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INVESTING IN INFRASTRUCTURE
The potential economic impact of investments in infrastructure--such as
highways, bridges, airports, and water systems--varies greatly. Evidence
strongly suggests that investment in certain types of these projects produces
long-term economic returns as well as creates jobs in the shorter term.
However, to the extent that existing infrastructure assets can be used more
efficiently, the need for new infrastructure can be reduced.
Investment in transportation infrastructure can create economic benefits by
improving mobility for people and goods. Our analysis and that of the
Congressional Budget Office (CBO) [ Footnote 6: _How Federal Spending for
Infrastructure and Other Public Investments Affects the Economy_, CBO (July
1991). ] suggest that maintenance work on existing highways provides
particularly significant benefits because it postpones the need for expensive
highway reconstruction at a relatively modest cost. CBO has estimated that
maintenance work can earn a 30- to 40-percent rate of return. Improvement and
modernization of the nation's air traffic control system may also have a
positive economic impact.
But expanding and improving the nation's supply of transportation
infrastructure is not the only way to achieve federal investment goals.
Influencing demand can reduce congestion by fostering more efficient use of
existing facilities at less cost to the government. For example, a recent
Brookings Institution study [ Footnote 7: Clifford Winston and Barry
Bosworth, "Public Infrastructure," _Setting Domestic Priorities: What Can
Government Do?_ ed. Henry J. Aaron and Charles L. Schultze (Washington, D.C.:
The Brookings Institution, 1992). ] observes that congestion pricing for the
use of roads and airport runways could create approximately $15 billion in
annual net benefits by reducing travel delays. More detailed information on
our nation's transportation infrastructure appears in _Transportation Issues_
(GAO/OCG-93-14TR), another document in this transition series.
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INVESTING IN HUMAN CAPITAL
An educated and well-trained population is more productive and thereby
enhances national economic growth. Investments in the productive capacity of
people are accomplished mainly through activities such as education and
training. Yet a significant proportion of our population is not receiving the
education and training needed for full participation in the economy. According
to a joint report of the Departments of Labor, Education, and Commerce, [
Footnote 8: _Building a Quality Workforce_, U.S. Departments of Labor,
Education, and Commerce (July 1988). ] 66 percent of employers consulted
considered the academic preparation of recent high school students for the job
market inadequate.
Returns from education and training--for example, the ability to read and
write--are economic as well as social. However, the link between federal
education and training programs and the nation's economic performance is
difficult to quantify, as CBO has noted. First, the relatively small federal
investment in human capital programs--as compared with that of state, local,
and private entities--makes it hard to isolate the effects of federal
programs. Second, it is often difficult to separate the contribution of
federal programs from that of important socioeconomic and demographic factors
that may also affect participants' behavior.
Despite the difficulty of quantifying programs' effects, particular programs
have produced some encouraging results. For example, CBO cites a study finding
that the Job Corps program appears to have been a good investment. [ Footnote
9: _Evaluation of the Economic Impact of the Job Corps Program: Third
Follow-Up Report_, Mathematica Policy Research Inc., (Washington, D.C.:
Mathematica, Sept. 1982), cited in _How Federal Spending for Infrastructure
and Other Public Investments Affects the Economy_, CBO (July 1991). ] For an
investment of about $10,000 in the average participant, society obtained a
stream of benefits worth almost $15,000. Recent research has also demonstrated
that education and training programs for welfare recipients can increase
earnings and reduce dependency. An ongoing study of the effects of the Job
Training and Partnership Act provides some evidence that the program has a
positive impact on adult earnings. [ Footnote 10: _The National JTPA Study:
Title IIA Impacts on Earnings and Employment at 18 Months_, Abt Associates,
Inc. (May 1992). ]
Thus, the technical difficulties of measuring their effects should not exclude
human capital programs from a federal investment strategy. Performance
measures are currently incorporated into the Job Training Partnership Act
(JTPA) programs and are being developed for the Job Opportunities and Basic
Skills (JOBS) Training program. Such measures can provide important feedback
to federal, state, and local policymakers and managers as they endeavor to
craft and implement the most cost-effective human capital investment programs
possible. Some of these measures are discussed in our transition series
report, _Labor Issues_ (GAO/OCG-93-19TR).
Additionally, research on the effects of education and training on
participants--such as is currently being conducted in the JOBS program--could
provide information for determining the long-term relationship between
economic gains for participants and for the nation.
In these ways, we can improve our ability to make the most of current human
capital programs and to determine how future education and training policies
can best enhance productivity.
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INVESTING IN RESEARCH AND DEVELOPMENT
Research and development (R&D) contributes to long-term growth by promoting
innovations in technology and work processes. However, as for human capital
initiatives, techniques for predicting the economic returns of specific R&D
investments are not well developed. Here again, lack of specific data should
not exclude R&D programs from consideration as investment programs.
Unlike many of its trading partners, the United States has generally not
invested in R&D to support civilian industrial technology. For example, in
1987, only 0.2 percent of all R&D spending in the United States was for
civilian industrial technology, as compared with 15.3 percent in Germany. [
Footnote 11: Linda R. Cohen and Roger G. Noll, "Research and Development,"
_Setting Domestic Priorities: What Can Government Do?_ ed. Henry J. Aaron and
Charles L. Schultze (Washington, D.C.: The Brookings Institution, 1992). ]
Similarly, federal R&D spending has been oriented towards agencies' specific
mission-related goals, primarily in the areas of defense, energy, and health.
Consequently, the contributions of federal R&D programs to economic growth
have generally not been assessed.
As the nation reduces the share of R&D spending for defense, it may lose some
of the civilian spin-off benefits that it realized from these expenditures.
This raises the question of whether and how federal spending should be
redirected to provide other means of encouraging R&D that promotes economic
growth.
As federal R&D strategies are developed, however, close attention to their
design will be needed. In one study, for example, we found that programs to
transfer advanced technology to small manufacturers were not aligned with the
needs of the manufacturers. Instead of laboratory-based technology--like the
computer-based manufacturing systems provided by the programs--these small
manufacturers needed proven technology to solve routine production problems. [
Footnote 12: _Technology Transfer: Federal Efforts to Enhance the
Competitiveness of Small Manufacturers_ (GAO/RCED-92-30, Nov. 22, 1991). ]
In another study, we found that the research and experimentation tax credit,
which cost over $7 billion in foregone revenue, stimulated research and
development worth only $1 billion to $2.5 billion, in part because a poorly
designed incentive structure reduced the subsidy for firms that increased
their R&D spending. [ Footnote 13: _Tax Policy and Administration: The
Research Tax Credit Has Stimulated Some Additional Research Spending_
(GA0/GGD-89-114, Sept. 5, 1989). In 1989, the Congress enacted changes that
probably improved the program's effectiveness. ]
The nation's long-term economic future depends in large part upon decisions
made today. The federal government needs to focus on the impact of current
decisions on the long-term economic health of the country. Failure to reverse
recent trends in investment will doom future generations to a stagnating
standard of living and damage U.S. competitiveness and influence in the world.
In fact, we are today already paying this price.
Current federal policy not only fails to promote long-term investment but also
violates the maxim to "do no harm," as the deficit absorbs private savings
needed to improve long-term growth. Therefore, starting to reduce the deficit
is essential to future economic growth. Within this overall fiscal policy
constraint, well-chosen public investments can also play an important role.
Reining in federal consumption spending, particularly for health care, is
essential both to reduce the deficit and to shift priorities within the budget
toward investment.
New public investment strategies and programs should be scrutinized carefully
lest public investment become a new catchword to justify the claims of
programs with only tangential long-term economic benefits. Moreover,
policymakers should consider other tools besides spending, such as pricing or
regulation, that may achieve federal investment goals more cost-effectively.
In the last decade of the 20th century, the U.S. government must accept
accountability for the long-term impact of its decisions. Only if we focus on
the future can we provide an ever-improving standard of living for future
generations.
