Monday, 15 December 2014

The transformation of Latin America and the Caribbean and its new challenges

By Michael Burke

The author recently made a presentation on this subject to a workshop at the highly successful LatinAmerica2014 conference in London. This piece is based on the notes for that presentation.

The economic growth rate of the Latin American and Caribbean countries as a whole has changed dramatically from the beginning of this century. Living standards have improved after a lost generation from the 1980s onwards. Tens of millions have been lifted out of absolute poverty and many more have seen their lives transformed. It is important both to learn from this process and to understand the threats to it.

The World Bank offers a variety of measures of real GDP. For a continent such as Latin America it is important to use a single international currency, in this case US Dollars. On this basis, in real terms the growth rate of the entire continental economy accelerated sharply in 2000. In the 20 years from 1980 to 2000 the average annual real growth rate was just 2%. From 2000 to 2013 this has increased to over 3.3% per annum. The change in the trend growth is shown in Fig. 1 below.


Fig.1 Latin America & Caribbean, Real GDP, US$ 2005

The transformation is even more apparent in per capita terms. As the population grows real GDP needs to grow simply in order to maintain average standards of living. Arithmetically, real GDP growth must exceed the growth of the population if, in practical termsaverage living standards are to rise. Until the beginning of this century real GDP growth was insufficiently strong and per capita GDP stagnated. Since that time, per capita GDP has grown. This is shown in Fig. 2 below.

Fig.2 Latin America and the Caribbean, Real Per Capita GDP, US$

Per capita GDP is an average measure. It can disguise both large and growing inequality in incomes, as one class claims most or all of the benefits of growth. But this has not been the case in Latin America in the recent past. Fig. 3 below shows the transformation in the lives of the poorest classes of society - those earning $2 a day or less. In 2002 there were 108 million people in Latin America and the Caribbean subsisting on less than $2 a day. In little more than a decade this total has been more than halved to 53 million people. In total 55 million people or almost 1 in 10 of the entire population has been lifted out of absolute poverty.

Fig.3 Latin America and the Caribbean, Persons Living on $2 a day, millions

A similar pattern is evident from a range of indicators. The numbers living on less than $4 a day has fallen over the same period from 236 million to 159 million since 2000. This is crucial. The rise to $2 a day means that people can generally expect to eat most days. Above $4 a day people can also begin to move beyond basic necessities and establish at least some quality of life. Most important of all average life expectancy at birth has risen by 3 years, from 71 years to 74 years. This is the most fundamental social indicator of all indicating improvement in living conditions and prosperity and is only possible with a combination of increased access to a range of foodstuffs, improved healthcare and housing.

There are a large number of indicators of poverty reduction and social progress which point in the same direction, although some important indicators of the position of women have not improved or have even gone backwards. These are significant omissions which need addressing. But taken as a whole the improvement in the economy, the general well-being of the population and its poorest members have also shown remarkably rapid and dramatic improvement since the beginning of this century.

Source of growth

Many Latin American and Caribbean economies are exporters of basic commodities. Like all commodity producers they benefited from the strong rise in global commodity prices in the early years of this century. The increase in commodities’ prices is illustrated in Fig. 4 below, as the commodities’ research Bureau (CRB) aggregates a basket of many of the key commodities’ prices, which doubled in price over the period.


Fig.4 CRB Commodities Index, 1993 to 2012
Source: Reuters/CRB

However the widespread assertion that exports were the sole or even main contributor to regional growth is a misconception. The accurate picture is that the increased export earnings from rising commodities prices were a catalyst for growth in general but that this growth was led by investment. This is shown in Table 1 below which itemises the growth rates for GDP and its components since the beginning of this century.

Table 1. Latin America & the Caribbean, Growth of GDP & Its Components, 2000 to 2016 (Forecasts)

For most of the period 2000 to 2012 exports were one of the weaker components of GDP growth. Over the period as whole they grew more slowly than GDP itself. Furthermore for the entire period exports grew more slowly than imports. As a result net exports actually subtracted from growth.

The leading component of growth was fixed investment. This conforms to economic theory, where the amount of capital deployed and the growth of the workforce and its quality (via training and education) account for the overwhelming bulk of growth. In the most accurate terminology, fixed investment is the accumulation of the productive capacity of any economy. As previously noted, both consumption and living standards improved dramatically over the period. But consumption cannot be an input into growth. If consumption growth exceeds output, it can only be sustained by increased indebtedness which actually leads to lower living standards. The increase in both private and public consumption was only made possible through the sustained increase in fixed investment, which was the strongest component of GDP growth by some distance.

It was only in 2010 and 2011 that exports grew more strongly than GDP. This was a result of global quantitative easing led by the US and the modest recovery in the leading economies which had the effect of driving up global commodities prices even further. But this produced its own negative effect. 2012 was the first year where fixed investment growth lagged GDP growth and the economy has slowed since. As resources are diverted away from investment economic slowdown inevitably follows.

Problems caused by the US

The period 1980 to 2000 was a lost generation for Latin America. The US had overthrown the Allende government in 1973 and held sway over the continent mainly through its alliances with brutal military dictatorships. The revolts against the dictatorships in Nicaragua, El Salvador and Grenada were all blocked or overturned by the US or US-backed forces.

It was this US dominance in the region which paved the way for economic collapse. The US had unilaterally withdrawn from the Bretton Woods currency system in 1971, provoking a global spike in commodities’ prices. It was forced to do so because it was unable to finance both the Viet Nam war and domestic consumption at the prevailing exchange rate. This fall in the US Dollar/rise in commodities’ prices resulted in a huge increase in the Dollar export earnings of the oil producing states, concentrated in the Arab world.

The oil producers, led by Saudi Arabia effectively bailed out the US through a huge inflow of those earnings in the form of ‘petro-Dollars’ into US banks. As well as financing US budget and trade deficits these funds were also used to boost US banks overseas lending, especially in Latin America.

The global downturn of the late 1970s left these borrowers exposed, primarily government borrowers. A full-blown currency, debt and economic crisis was marked by the Mexican government’s debt default in 1982. At US insistence, it was the US banks that were rescued, not the Latin American economies, through the issuance of ‘Brady Bonds, named after the US Treasury Secretary. Debt crises in a host of other countries followed and the resulting debt burden sucked capital from South to North over the following decades and led to economic stagnation and misery.

These gyrations are not solely of historical interest. The role of the US Dollar as the major reserve currency and the denominator for virtually all globally-traded commodities means that significant or abrupt changes in US economic and monetary policy are magnified in commodity-producing and/or debtor economies. Sharp changes in US monetary policy always lead to sharp dislocations in the rest of the world, especially in ‘emerging markets’. As the US is also the world’s largest net debtor economy, it has a constant necessity for inflows of overseas capital. In periods of economic expansion this need increases sharply. Changes in US monetary policy are conditioned by this requirement for capital generated in the rest of the world and so can cause abrupt and hugely dislocating flows of capital in other countries.

This is precisely what has happened in the most recent period. The US Federal Reserve Bank ended its third round of quantitative easing on October 29. This had helped to inflate financial assets included commodities prices from 2010 onwards. Now the US is consciously aiming to drive down key commodities’ prices. The US has agreed with the key oil producer Saudi Arabia that the oil price should fall. On the US side this is an extension of the sanctions against Russia, but it welcomes the collateral damage to countries such as Venezuela, where sanctions are now also threatened.

New challenges

Politics comes before economics. The economic transformation of an entire continent cannot happen randomly. Across the region (with certain exceptions) through decades of upheaval a political leadership has been forged that rejected the dominance of the US and its neoliberal economic policies. The period 2000 to 2002 was marked by the sharp turn of Hugo Chavez’s revolutionary government in Venezuela towards Bolivarian socialism, ending generations of national humiliation. Shortly afterwards the serial humiliations inflicted on Argentina hit a brick wall with its default. Then in 2002 the Lula and the Brazilian Workers’ Party won the Presidential election.

Although they represent different social coalitions their common platform is a desire for economic growth, and the improvement of the living standards of the population, in particular the poorest layers of society. In different ways they draw inspiration from the Cuban revolution and its determined resistance to US rule.

It is important to stress that economic redistribution was an outcome made possible by growth. It was not the driver of it. The principal economic contributor to the economic transformation was the rise in fixed investment. Until 2012 fixed investment was the strongest component of growth and was its leading element. Growing trade, including intra-Latin American trade was a key catalyst for investment-led growth. This in turn allowed the growth of both public and private consumption, which indicates the general rise in living standards.

But the catalyst of rising export revenues has gone into reverse. At the time of writing the CRB Index had fallen to 247, close to levels last seen at the depths of the crisis in 2008. The oil price has fallen below $65/bbl a new 5-year low. This is a direct consequence of changes in US policy. This is in effect a crisis of 2008/2009 proportions for most of the commodity-producing economies, which takes in virtually the entire continent of Latin America and the Caribbean.

The growth of fixed investment has slowed to a crawl, which will prevent any sustainable revival of GDP growth. This is illustrated in Fig.5 below with reference to Brazil, which is by far the largest regional economy and accounts for nearly 40% of the entire continental GDP. This shows Brazilian Gross Fixed Capital Formation (GFCF) as a proportion of GDP, both the total and the specific contribution of the private sector. From 2002 onwards the long-term decline in the investment rate was being reversed. But there has been a renewed decline in 2012 (and other data suggest this has been extended since).


Fig. 5 Brazil GFCF, Total and Private Sector, % of GDP

Capital outflow

There is also a new threat in the form of capital outflow. The US is the dominant financial power in the world and the US Dollar the main currency denominator not only for commodities but also for international debt. Yet the US has a structural capital shortage, as shown by its chronic deficits on the balance of payments. In periods where US capital is seeking to expand, it is obliged to suck in capital from the world. The outflow of capital from ‘emerging market economies’ was recently the subject of a strong warning from the Bank for International Settlements (BIS). This is a specific threat to the Latin American economies.

The BIS data show that Latin America and the Caribbean owe BIS-reporting banks (the banks of all the industrialised economies) a net amount US$1.337 trillion. Of this $565 billion is held in foreign currencies, which is virtually all in US Dollars. The overwhelming bulk of this US Dollar debt is owed by both private sector firms and banks based in the region and is owed to Western banks. US Dollar debt owed by governments is a relatively modest $113 billion.
In addition to the challenge posed by falling commodities’ prices and the need to reverse the sharp slowdown in the growth rate of investment, it is the region’s private sector firms which are the Achilles Heel of the economy.

The regional firms and banks are no longer benefitting from the rise in exports and are primarily responsible for the sharp slowdown in investment. They are also the primary source of capital outflow from the domestic economies, and will in many cases be directly responsible for it. They are likely to come under severe pressure as they absorb the effects of lower exports, slowing domestic economies and rising debt-servicing costs. There is no point in minimising the scale of these difficulties. They amount to a new crisis for the entire region and need a new response.

Responding to the new threats

A revival of growth is vital for a return to rising living standards. Three key steps are required, each of them interrelated. Returning to per capita GDP growth depends first on reviving the growth of fixed investment. Secondly it is necessary to soften the blow of falling export prices by increasing trade diversification. This is both a geographical diversification as well as adopting measures to increase the value created in production by increasing the output of finished goods and manufactures, compared to basic commodities. Thirdly a series of strong defensive measures are needed to insulate the region from the US-driven outflow of capital.

The decline in fixed investment is primarily the responsibility of the private sector. Since private sector investment is determined by the anticipation of profits a spontaneous recovery cannot be relied on, especially in the current conditions. Therefore the state sector must increase its own level of investment. It can do so in a number of ways, including directing domestic banks to increase productive investment by cutting back on speculation or other useless activity. It can regulate the level of private sector firms’ investment by legislation and other means (including in the awarding of government contracts). It can also apply windfall or other confiscatory taxes to fund direct government investment. If the private sector resists any of these measures, all necessary steps can be taken to overcome that resistance, including nationalisation.

One of the great successes of the period of expansion has been increasing continental economic co-operation through a variety of regional bodies, including Mercosur/Mercosul and ALBA. This helps to break down colonial patterns of development, where nearly all international trade was formerly geared towards exports of basic goods to the US. The deepening of regional ties through increased trade and infrastructure projects can help to soften the blow of falling commodities’ prices. But it is also important to move higher in the value chain of production and away from basic goods. Over the long-term manufacturing has been in decline as a proportion of GDP across the region. Increasing regional value creation requires both development of the economic capacity and access to hi-tech investment products. Here the two key potential allies are the deepening of ties with China and Russia. The former can provide funding for regional infrastructure and both can provide access to hi-tech investment goods, vital to revival of manufacturing and increasing value-added.

The outflow of capital represents an immediate and significant threat to regional prosperity. National savings need to be protected from US predations. Strong counter-measures are required. These may include restrictions on financial trading, capital controls and taking state ownership and control of the banks where necessary, as they facilitate the highly damaging outflow of capital.

Conclusion

Latin America and the Caribbean have seen a remarkable transformation in the most fundamental of living standards of the population in the first decade of this century. The first condition was the forging of a political leadership capable of coming to power and ending US domination.
Economically they were able to achieve this as the commodity-producing economies of the region benefited from the global rise in commodities prices. But this benefit was used to fund investment, which was the leading component of growth. It was the rise in investment which allowed the rise in living standards.

Now commodities’ prices have gone into reverse. Yet it remains the case that only increased investment can lead to increased prosperity. Therefore new radical measures are required in order to fund investment. Continuing the transformation in distribution will require a transformation in production.

This is centred on the direction of private sector firms and banks operating in the region. They have reduced their level of investment in the face of falling commodities prices and a slowing economy. They are also the primary source of the potentially disastrous capital flight from the region, which is being orchestrated by the US to destabilise its enemies and for its own benefit. Only by directing their levels of investment can growth be resumed. In some cases taking ownership of some of these banks and firms can the governments continue with their policies of economic and social transformation.

Saturday, 6 December 2014

Renewed, increased austerity will only produce a worse result

By Michael Burke

The scale of cuts set out in George Osborne’s latest Autumn Statement are so large that they are quite unfeasible without a fierce attack on public spending, services, jobs and pay over the next five years. Even in the likelihood that targets are missed the effect will be to deepen austerity and permanently embed it in the economy.

The Office for Budget Responsibility (OBR) forecasts the level of austerity in the next five years will be much worse than the last five. The OBR is extremely poor at economic forecasting as it shares the Treasury’s flawed economic model. It also consistently paints a favourable picture of the outcome of all government policies. Even so its closeness to government means that it is well placed to understand government intentions. It projects further cuts to government current spending equivalent to 4.8% of GDP in the next parliament. This compares to 3.4% of cuts in current spending under the Coalition. This is shown in Fig.1 below. In cash terms the cuts will increase from £35bn so far to another £55bn in the next parliament.

Fig.1 Actual & Projected Change in Government Current Spending, % GDP
Source: OBR

The government claims that certain key items of spending have been ‘ring-fenced’, which in reality means capped. The key capped items are spending on pensions, education and the NHS. As Fig.1 shows this still means education and NHS spending are falling as a proportion of GDP even though the population is both ageing and growing. The real education and health spending per pupil or per patient is falling, hence the rising waiting lists in both areas.

The Institute for Fiscal Studies suggests that the capping of these items means that other items in the budget will be cut by up to 40%. In previous austerity measures the scope for cuts was facilitated because of items of highly beneficial but non-essential services built up over previous decades. But the cuts to youth services, day care for the elderly, closures of public services have all nearly run their course. They have been highly damaging but now essential services are the sole real target for cuts.

The increased austerity totals outlined in the Autumn Statement will be much greater than the austerity to date. Their effects will be magnified because essential services are the main target for the cuts. They cannot be achieved without a ferocious attack on public services, public sector pay, jobs and pensions.

Outlandish assumptions

In addition to cuts in government current spending the OBR projection is that government investment will be cut further. Under the Coalition public sector investment has fallen from 3.2% of GDP to 1.5%. The OBR projects it will now fall to 1.2% of GDP in future years.

SEB has previously shown that business investment follows government spending and investment with a time lag. The false Treasury/OBR framework is that the state is an obstacle to the private sector. So, the OBR projects a sharp rise in business investment over the next 5 years, much faster than the recent period when activity is usually strongest in the recovery period. This is despite the fact that government spending is cut more deeply. The OBR forecasts for business spending are shown in Fig. 2 below and are compared to previous recessions.

Fig.2 Business Investment in Three Post-Recession Periods, OBR Projection

This surge in business investment (exceeded only by the unsustainable ‘Lawson boom’ of the 1980s) is projected to arise even though there is simultaneously a forecast profits squeeze. According to the OBR the Gross Operating Surplus of firms will grow by just 4.1% over the next 5 years in nominal terms. After inflation the real terms level of profits will fall. By contrast the Compensation of Employees is projected to rise by 11.1% over the next 5 years. Therefore both the wage bill and the additions to new capital will exceed the growth in the operating surplus. The profit rate will fall as a result.

These are simply outlandish forecasts. As firms invest in anticipation of increased profits the OBR forecasts are wholly unfeasible. This rise in business investment is central to the OBR’s projection of moderate but sustained growth, along with increasing household debt. Even so, its forecasts show a significant slowdown from current growth rates. The 3% growth in GDP this year is the best of the recovery even on the OBR’s rose-tinted view. In reality cuts on the scale envisaged would risk a much deeper slowdown or even recession.

Political impact

Even if the government/OBR forecasts for the scale of the cuts prove to be unworkable they amount to a plan for permanent austerity, of ever deeper cuts. They are also a Tory trap for Labour, which has said it will also aim to balance the budget without challenging the framework that it is the investment strike and weak growth that causes the deficit.

Prior to the 1997 election New Labour signed up to Tory spending plans in the first two years. Politically the effect was that New Labour immediately lost 1.5 million votes in that post-election period, a third of the total votes lost over 13 years in office which ended in defeat in 2010.

Currently a Labour-led government is in no position to lose 1.5 million votes after May 2015. But the economic situation is fundamentally different to the position at the turn of this century. Increased government spending cushioned British growth from the general downturn in the industrialised economies in 2000. As SEB has previously shown, this reversal on spending was very partial. But with the tailwind of global recovery after 2000 economic crisis was averted. It was the stagnation of living standards which caused the attrition of a further 3 million votes for new Labour over the next decade.

This situation is very different. With a commitment to balance the budget by cuts, there is no scope to increase spending in the middle of the next parliament. The global economy is unlikely to provide as much support as most forecasts anticipate a slowdown. Crucially, living standards are not stagnating but declining for the overwhelming majority of the population. Without reversing policy abruptly this fall will in living standards will continue. Renewed austerity will accelerate the decline. The economic and political consequences are easy to foretell. If pointers are needed the political and economic fortunes of the current Socialist government in France can provide them.

Wednesday, 3 December 2014

New Labour spent less than Thatcher. That was part of the problem

By Michael Burke

In all the commentary related to Gordon Brown’s decision to step down as MP there is one central myth that has been retold almost without any challenge. This is the idea that his excessive public spending was responsible for the economic crisis and/or the surge in the deficit on the public finances.

It is important to debunk this myth not primarily for reasons of establishing the historical record. The more important task is to puncture the myth that the crisis was caused by the public sector because this is used to justify the continuation of austerity measures and prevents any discussion of the real causes of the crisis or its remedies. The actual cause of the crisis was an investment strike by the private sector, which has not been broken.

The record

The actual position is that New Labour cut government spending dramatically. It did the same to tax revenues. It was the crisis which reversed that as the private sector investment strike both caused unemployment to rise and so pushed up government spending and lowered tax revenues (income tax, VAT, corporate taxes, and so on). But even then, government spending rose to only the same level as under Thatcher.

The trends in public sector revenues and expenditures as a proportion of GDP are shown in Fig.1 below.

Fig.1 Public sector revenues and expenditure % GDP

Any deficits under New Labour prior to the crisis are therefore attributable to the very low level of tax revenues that were gathered.

The detailed comparative record is set out in Table 1 below (based on UK Treasury data, which is now presented by the Office for Budget Responsibility).

Table.1 Average Spending & Tax Receipts Under Four Prime Ministers
Source: OBR * Last year only

The low-point for spending in this period examined was under Blair. It equalled the low-point in spending recorded by the Tory austerity government of the 1950s.

Uninterrupted decline

It is evident that under New Labour there was room both to increase taxation and spending. Fig.2 below shows the level of government investment as a proportion of GDP. OBR forecasts for future years are included.

Fig.2 Government Investment, % GDP
Source: OBR

In the mid-1970s the right wing leadership of the Labour Party led by Callaghan and Healey manufactured an entirely fake crisis of government borrowing with the connivance of the IMF. The purpose was to launch an attack on public spending and government investment. This became explicit policy (justified with all sorts of monetarist nonsense) under Thatcher. There has been no decisive break from this policy framework in the period since.

This policy has been disastrous. British growth was regarded as relatively very weak in the post-World War II period up to the mid-1970s. The process of cutting public spending, cutting public investment, deregulation and privatisation actually lowered growth considerably. In the years between 1948 and 1981 the economy grew by 147%. Despite the boon of North Sea oil, GDP grew by just 110% in the following 32 years.

Key to this decline was the decision to slash public investment. It is driven by the belief that, if the state’s role in the economy is reduced the private sector will take its place, and in a more efficient manner. New Labour extended this policy. The result was that private sector freedom did not lead to increased investment but to increased speculation in areas such as housing. The whole history of this policy has led to the current crisis.

The Tory-led Coalition has continued this policy in a very aggressive way. Public spending has been cut and public investment has been slashed. As previously this will not lead to increased investment or prosperity. Instead, as already noted, financial bubbles and crashes are what happen when the private sector is in charge.

Thursday, 27 November 2014

Latin America Conference 2014

9:30am - 4:30pm Saturday, November 29th
Congress House
Great Russell Street London WC1B 3LS


This years Latin America Conference brings together political leaders, trade unionists, NGOs, academics & progressive movements to explore recent developments across the region, along with films, music and exhibitions showcasing Latin American culture.

With special guests:
• Aleida Guevara, daughter of Che
• Juana Garcia, Venezuelan Women’s Ministry
• Alicia Castro, Argentinian Ambassador
• Guillaume Long, Senior Ecuadorian Government Minister
• Guisell Morales Echaverry, Nicarguan Charge d’Affaires

Plus:
• Miguel Angel Martinez, former Vice-President, European Parliament
• George Galloway MP
• Chris Williamson MP
• Christine Blower, NUT General Secretary
• Kate Hudson, CND
• Andy De La Tour, Actor
• Tariq Ali, writer
• Owen Jones, writer

And films, stalls & discussion on topics such as:
• Cuba: building a better world under the eye of the empire
• After Chavez – the Empire strikes back in Venezuela
• Nicaragua, 35 Years on – the second Sandinista Revolution
• For Peace, Development & Progress – the new Latin America in the World Today

Friday, 21 November 2014

What do Britain’s private sector firms contribute?

By Michael Burke

The main factors that account for economic growth are increases in the workforce or in the amount of productive capital in the economy. A far smaller contribution is made by improvement in productivity as a result of innovation, which is known as Total Factor Productivity.

Since mid-2009 the British economy has grown. But this is wholly accounted for by growth in the workforce, which made up of both an increase in the number of people in work and in the number of hours they work. As a result the average person in work cannot experience any improvement in living standards as economic growth is simply made up of more people working longer hours. Worse, those on very high pay, senior executives and shareholders, have claimed any benefits of that moderate growth in the British economy. Average real pay continues to decline.

The missing element in Osborne's so-called recovery has been growth in productive investment. The ONS chart below shows the level of Net Fixed Capital Formation in the British economy from 1999 to 2013 as a proportion of GDP. Usually Gross Fixed Capital Formation (GFCF) is the main indicator of investment that is discussed. But Net Fixed Capital Formation deducts the capital consumed in the production process itself. While GFCF includes replacement of machine tools, or software and repairs to a factory, NFCF is a measure of only the net addition to new machine tools, software or factories after any replacements have been deducted.

NFCF therefore measures the addition to the accumulated stock of capital. (Unfortunately it also mixes together productive capital, such as machinery, with unproductive capital such as housing, but this failing cannot be addressed in this piece). The chart also shows the contribution to NFCF from each sector, non-financial firms, financial firms, government and households.

Fig. 1 Net Fixed Capital Formation, % GDP
Source: ONS

The data is worth examining in detail. The net contribution of financial firms can be disregarded as it is negligible in all cases. But it is also clear that the contribution of non-financial corporations (NFCs), i.e. private companies, has been far from overwhelming.

Table 1. Contributions to Growth in Net Capital Stock by Sector, % GDP
Source: ONS

In most years before the crisis the net contribution from non-financial firms was matched or surpassed by the contribution from households (and the non-profit sector NIPISH). The strongest year for the net growth in the capital stock was 2004, when the greater role was played by government and non-financial firms contributed just one quarter of the total growth. But this increase in government spending encouraged the private sector and the following year saw an increase in the contribution to NFCF by private firms. But from that point onwards until 2009 government NFCF was once again reduced and in turn, with one year time lag, companies duly cut their own level of investment. With a time lag, companies also followed when government increased its investment again after 2008. Yet non-financial firms never contributed as much as half of the net growth in the capital stock in any year over the period.

Outlook

The coalition government has been claiming that it has overseen a revival of the British economy, including business investment. But the total proportion of NFCF is barely changed from the crisis year of 2008, along with the contribution from non-financial firms. In reality, it was the modest increase in government net investment in 2009 which rescued the economy and has been responsible for well over half the growth in net investment since. Non-financial firms have contributed less than a third of the NFCF over the same period. Yet the Coalition cut the level of investment it inherited from Labour and has only increased it modestly to avoid the political consequences of a renewed recession.

Over the longer-term Britain has a very low level of net capital formation, less than 2.5% of GDP at its recent high-point, which condemns the economy to slow growth. Even among the Western economies that have experienced a decline in growth rates over the medium term, Britain has had one of the lower levels of NFCF. It is notable too that the US has among the weaker levels of net investment growth since 2006, which belies notions about a US industrial renaissance.


Fig. 2 Net Fixed Capital Formation in Selected Economies, % GDP
Source: ONS


Unfortunately, the Thatcherite and Reaganite notion of the ‘state getting out of the way of the private sector’ still dominates thinking in most Western economies. This turns reality on its head. Private firms are an important but minor player in the growth of the net stock of capital. They are led by the activity of the government. This was decisive during the crisis and there is no prospect of a return even to previous levels of British growth if it is mainly dependent on the contribution of private firms. The austerity consensus remains that government must cut back while we await the decision of private firms to increase their investment. This will condemn the economy to prolonged stagnation.