Questions and answers: Why investment not cuts is key

The debate on the alternatives to the current failed economic policy of the government has intensified. The renewed downturn in Europe, a British government Budget whose cut in the 50p tax rate underlined the class interests it represents and the slip back into ‘double-dip’ recession have all heightened interest in alternatives to ‘austerity’.

Socialist Economic Bulletin has consistently argued that the appropriate response to the current crisis is investment, not cuts. A number of readers have expressed interest in a Frequently Asked Questions, addressing some of the main points of this. These are set out below.

What do you mean by investment?

What we mean by investment is investment in machinery, transport, technology, housing and hospitals and similar things. This is not the speculation, sometimes wrongly called ‘investment’, which is often spoken of in relation to the stock market and other financial instruments.

All economic output is either consumed or set aside in the form of savings by households, companies or the government. This saving can sit idle in a bank, be used for speculation, or used for investment in building houses, infrastructure, transport links, education, health care, and so on. It is this latter type of investment which creates prosperity and jobs as well as improving productivity. It is what is meant by the term investment.

From a socialist point of view, investment is about ‘the means of production’. The question of who controls the means of production and how they are developed is the most important issue in the economy. Most of the time this issue appears abstract, but in a big economic crisis such as the present the question of who will control, or set the policy of the means of production, is an immediate issue.

Why has the question of investment become so important currently?

The fall in investment (gross fixed capital formation) in the OECD group of industrialised countries from 2007 to 2010 was approximately US$963bn in real terms. This is vastly more than the total decline in GDP, which was US$220bn. This was because other components of GDP, such as household or government spending as well as net exports to the rest of the world all rose. In order to reverse the slump, there must be a recovery in investment.

Is the same true for Britain?

It was. Until the Tory-led government came to office the decline in investment was the biggest contributor to the British recession and accounted for approximately 80 per cent of the decline in GDP. Declining investment also led the recession, beginning to fall before the economy as a whole contracted.

How has the recession changed since the Tory led coalition took office?

On the same basis as the OECD as a whole (US$ at Purchasing Power Parity), the decline in investment now accounts for the entirety of the British recession. The difference is that it has been joined and then overtaken by the decline in household spending. This is a result of government policy, where wage freezes, the VAT hike, benefit cuts and job losses have combined with higher inflation to push real incomes down. As a result household spending has also fallen. To get out of the recession therefore means that both people’s incomes, which determine consumption, and investment must be increased.

If there’s no money left, how can investment be increased?

There’s plenty of money left! If wages are held down and yet prices (for food, energy, rent, transport costs, etc.) are rising this means that the share of national income of companies or landlords or transport operators will all rise. Their share of national income is profits. But companies are refusing to invest this profit.
Where they can, companies are holding down wages and hiking prices but in general are refusing to invest.

As a result, they are sitting on a cash mountain (held in the banks) of around £750bn. Capital is plentiful. Currently it is in the hands of those who refuse to invest it. This refusal has led the economy into a double dip recession. The only way to reverse this is to raise people’s income, which means to stimulate consumption, and at the same time to embark on a major investment programme.

But is that enough?

It is more than enough to deal with the scale of the current problem. To restore all the lost output since the recession would require just £67bn. To restore the British economy to trend growth, so that it would seem as if the recession had never happened, would require approximately £225bn. Both of these totals are just a fraction of the cash holding of the corporate sector.

How could this cash mountain be accessed?

Government policy could easily claim it, through a variety of levies, windfall taxes and surcharges. The funds are already held mainly in British banks (as companies become increasingly concerned about holding them in overseas banks) and could be directed for investment purposes. RBS and Lloyds-TSB are already owned by the state and all deposit-taking banks operating in Britain can only do so because the deposits are guaranteed by the state. A substantial part of this investment should be launched directly by the state in housing, transport and other sectors. As regards private companies, a simple instruction could be issued that the banks must provide investment (cheap loans) to all the areas needed.

What are those areas?

The priorities would be investment in housing, in transport (especially much more energy efficient rail), in infrastructure (hi-speed broadband, non-carbon energy generation, port facilities, and so on), as well as
in education at all levels. These are the areas which have seen the biggest falls in investment during the recession, and yet have potentially the biggest returns on investment.

But once the bridge is built, or new broadband supplied, isn’t the money gone?

All the money spent has very large multiplier effects. This means the money continues to circulate in the economy long after the initial expenditure. In addition, there are very large boosts to productivity, making it possible to establish or expand businesses and services. The CBI now accepts that the average multiplier for large infrastructure projects is 2.84:1, meaning that for every £1bn initially invested, the economy is boosted by £2.84bn.

There has been a lot of recent talk from the CBI and others on the need for investment. Isn’t this the same as SEB’s policy?

No. The CBI and others represent the business interests that have participated in the investment strike which is the cause of the crisis. Now, because demand generally is falling once more (investment, household spending, government consumption and exports) they are suddenly concerned about current and future profits. They have also benefitted from lower wages and falling corporate tax rates. Yet they continue to refuse to invest.

Instead, they demand that they be given further subsides, handouts and guarantees (even guaranteed profits in the case of the nuclear industry) in the hope they will graciously deign to invest at some point in the future when profits are certain.

Worse, they also demand further cuts in wages and employment rights, and further cuts in government spending on welfare. This is indefensible morally but it also runs counter to the needs of the economy as whole, where falling household incomes is now also driving the recession.

But wouldn’t those business subsidies be worth it, if it led to a recovery?

Private businesses are driven by profit, and in aggregate they will make no large scale investments without an increase in profitability. As this is a generalised crisis in the industrialised countries, autonomous large scale private sector investment can be ruled out because no sufficiently large recovery of profits is in sight.

Therefore all attempts to bribe private businesses to invest, such as the government’s ‘credit easing’ are likely to prove extremely costly or fail, or both.

Then how can investment recover?

The state is not driven by profit and so has the capacity to make rational economic decisions, based on what is required to optimise sustainable economic activity. The mechanisms for the state to access the private sector’s cash hoard have already been identified. It is a relatively simple matter to achieve it.

If this were so simple, why hasn’t it been done already?

In Keynesian terms, this would amount to a ‘somewhat comprehensive socialisation of investment’. The state would be taking over functions that have been ceded to the private sector, such as house building, and would derive the surplus generated by it in the form of rent.

It would begin to reverse the decades of privatisations begun in earnest under Thatcher. In Marxist terms it would mean some portion of the means of production passing from private to public ownership. This is not therefore acceptable to the current owners, and the political forces which support them.

But surely this is Utopian, talking about the state taking over the means of production?

Across the world, the efficacy of all stimulus or bailout measures was in direct proportion to the involvement of the state, which is why China’s investment stimulus was the most successful of all. Even in the US currently, it is the state-owned agencies Freddie Mac and Fannie Mae which are keeping the housing market going as private banks have exited the US housing market. All across the world, including Britain, it was the state which supported the failing private sector banking system. It is the state, in the form of EU subventions, which is funding rapid recovery in the Baltic states and which allowed Poland to avoid recession altogether.

The state is a more efficient provider of many large scale goods and services. If its weight in the economy overall is sufficiently great it can also have the levers to regulate the level of investment, which is decisive for continued prosperity.

What about other alternatives, like taxing the rich?

Britain is a very unequal society, made more so by the Tory-led coalition’s policies of reduction in real wages and cuts in welfare entitlements. A more redistributive tax system, and closing tax loopholes to pay for it, would be beneficial. But tax increases alone are not sufficient for reviving the economy. In the last financial year the public sector deficit was over £124bn. Even the most ardent supporters of increasing taxes do not suggest that the full armoury of tax increases could match this total.

Other schemes, based on further monetary interventions or quantitative easing, or increased wages, while all useful in themselves, do not address the central issue that significantly increased investment is required to revive the economy and that the only agent that can lead an investment recovery is the state.


A leaflet version of this article Questions and answers can be downloaded here.

The investment strike is one the government would do well to bust

Michael Burke has an excellent new post on the Guardian’s Comment is Free examining UK companies failure to invest and therefore why the state must intervene if the economy is to recover.

China's economy in the last 10 years has seen the fastest growth in per capita GDP in a major economy in human history

By John Ross

In the last 10 years China's economy has experienced the most rapid growth in per capita GDP in a major economy in human history. In the same period China has seen the most rapid increase in per capita consumption of any major economy. These are the principle findings of my analysis of the last 10 years of China's economic history. This shows those who claimed China's economy faced 'crisis' had no contact with economic reality. The data is in the tables below and my analysis is here.

The incredible shrinking UK economy - an update

By John Ross
Earlier this year this blog published an article entitled ‘The Incredible Shrinking UK Economy’. It noted: ‘The magnitude of the blow suffered by the UK economy since the beginning of the financial crisis is very considerably minimized by not presenting it in terms of a common international yardstick. Gauged by decline in GDP, using a common international purchasing measure, dollars, no other economy in the world has shrunk even remotely as much as the UK.’ .
Data at that time was only available up until the end of 2010. Since then the World Bank has updated its data to cover 2011 and the pattern remains the same.
Taking first the situation of the world’s major economies, the G7 and BRICS, this is summarised in Table 1. The comparison made is between the last year before the financial crisis started, 2007, and the last available comprehensive international data – for 2011. As may be seen the $381 billion decline, in current dollar terms, of UK GDP is, without comparison, the worst of any major economy – indeed it is easily the worst in the world. As a percentage of world GDP the UK lost 1.6 percentage points – easily the worst performance of any European economy. The advance of all BRICS economies is also clear from this data.

Table 1

Taking the situation within Europe this is shown in Table 2. As the UK, Ireland, and Iceland are the three economies which have suffered the biggest losses in GDP in dollars during the financial crisis this table may also be taken to show the ‘sin bin’ of world economic performance. The way in which the UK economy has declined in absolute terms far more than any other European economy is again evident.

Table 2

Where does this leave the UK in the world rankings of economies? In terms of current dollar exchange rates. as shown in Table 3, the UK has slid from 5th to 7th position under the impact of the international financial crisis – being overtaken by France and Brazil

Table 3

However, as is well known, current exchange rates substantially understate the size of developing economies compared to calculations in internationally equivalent prices (Parity Purchasing Powers - PPPs). This is particularly strikingly the case for India which at current exchange rates is only ranked 10th but in terms of PPPs in 2011 overtook Japan to rank as the world's 3rd largest economy . In PPPs the UK has declined from 7th to 9th position – also being overtaken by France and Brazil on this measure.

Table 4

The data is therefore clear. In terms of its real international position the decline in the position of the UK is by far the worst of any major economy. There is no reason to change the analysis. In terms of international comparisons the UK’s is truly ‘the incredible shrinking economy’

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This article originally appeared on the blog Key Trends in Globalisation.

The UK’s budget deficit is rising not falling

By Michael Burke
The latest public sector borrowing data shows that the UK budget deficit is widening once more. Indeed despite a series of accounting adjustments which obscure the true picture, it is clear that the underlying trend is also towards rising, not falling deficits.

The Office for National Statistics reports that the June public sector borrowing total was £14.4bn, £500 million higher than in the corresponding month in 2011. However monthly data are erratic and subject to significant revision. Taking the data for the first 6 months of this year as a whole is more meaningful and shows that the deficit over that period is £37.3bn.

But this total is flattered by the strange decision relating to the acquisition of the Royal Mail Pension funds ahead of planned privatisation. In effect the government has decided to include the assets of this fund, but not its much greater pension liabilities in its own accounts. This and another smaller transaction lowered government borrowing by £30.3bn. The underlying deficit, excluding these transactions is therefore £67.6bn in the first 6 months of this year.

This compares to a deficit of £60.5bn in the first 6 months of 2011. The deficit is rising, not falling.

Figure 1

Factors Affecting Borrowing

This deterioration in the deficit places British government finances in a growing band of European economies where sharp cuts in government spending are leading to economic contraction, which in turn produces widening deficits.

This should come as no surprise. As the crisis is effectively an investment strike by capital, spending cuts by government will only lead to a further decline in private investment. The reason this logic has taken some time to work through in Britain is due to a number of factors. These are primarily the zig-zag in government policy, which initially saw an very modest increase in government investment under Labour and so produced a reduction in the deficit. This was compounded by the uniquely high level of inflation during the British slump, which eroded the real value of all government spending.

SEB has previously shown that the very moderate increase in government investment from the 2009 Budget under Labour was the catalyst for a modest economic recovery. Because of the increase in government spending (including allowing welfare payments to rise automatically as unemployment and poverty increased) the Treasury forecast that the deficit would rise to £178bn in the following financial year. In the event, the deficit began to decline and was £158bn for the financial year.

In addition, the effects of economic growth are felt on both sides of government accounts. Expenditure is lower than it would have been because more are in work and the benefits’ bill falls. Revenues are higher because incomes, profits and consumption all raise the level of tax revenues.

It is widely known that government policies have led to economic stagnation. Yet it is only now that the deficit has started to rise. The British economy has grown by just 0.5% in the two years since the Coalition came to office. But in nominal terms, before taking account of inflation, the GDP has increased by 6.1%. This surge in inflation during the slump is highly unusual, placing Britain on a par with countries such as Iceland. Britain has an incredible shrinking economy when measured in international currency terms.

Domestically this is reflected in a surge in inflation. While severely denting the purchasing power of all those on fixed or low-growth incomes, the fiscal effect was to increase nominal government revenues by £56bn over the last 2 years. This compares to annualised nominal growth in GDP of £88bn.

The Treasury’s estimate is that every £1 increase in economic activity will lead to a 50p increase in government revenues. In fact the increase over the last two years has been 64p (£56bn of revenues of £88bn increased output). However, government current spending has also risen by £42.3bn over the same period. This is an inevitable consequence of the savings (i.e refusal to invest) by firms.

This points to the essential fallacy of all ‘austerity’ measures, whether from the Coalition’s frontal assault, or the slightly shallower, slower cuts favoured by current Labour policy. Even nominal growth will largely be reflected in increased government revenues. But spending cuts have the effect of weakening economic activity and so drive up government expenditures.

Even in the narrow terms of reducing the deficit, the only effective prescription is growth. The most effective means of promoting growth, as even the cautious 2009 Labour Budget shows, is for the government to increase investment.