Demand-Led Growth – Government Spending and the Investment Share

In the long run, a higher rate of economic growth implies a higher share of investment in income. This will necessarily correspond to a lower combined share of other forms of spending. Knowledge of this point sometimes leads to unfortunate calls to cut back government spending as a means of boosting growth. Yet, if private investment can be said, in a long-run context, largely to be induced by income – which is consistent with the evidence (see, for instance, here, here and here) – then a sustained increase in the growth rate of government spending and other components of autonomous demand could be expected, through their direct impact on income, to induce higher investment. It is not at all obvious that the investment share in income would fall as a result of this process. To the contrary, there is reason to expect the investment share to rise and the share of other spending (and quite possibly government spending) to fall in consequence of demand-led growth of this nature. The purpose of the present post is to explain this possibility.

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