There is a problem. A serious one. A recent ONS study notes that ‘Between Quarter 1 1997 and Quarter 2 (Apr to June) 2017, the UK had the lowest average value of GFCF (Gross Fixed Capital Formation) as a percentage of GDP of any OECD nation.’ And further ‘The UK has the lowest average non-government sector investment of any G7 nation as a percentage of GDP, along with the second lowest average government sector investment as a percentage of GDP.’
Digest that. Think about it. The problem isn’t a temporary or short-term one. It is a historical fixture, embedded in the UK economy as a way of doing things. It isn’t a failure of the public sector or of the private sector, it is a failure of both.
One grave consequence is what the Financial Times has described as ‘Britain’s productivity crisis.’ As the FT succinctly puts it, ‘It matters because achieving higher growth in productivity — or output per hour worked — is the way nations become richer, living standards rise and governments have the resources to improve public services or cut taxes.’
The problem manifests itself in a number of ways, some of which disguise the underyling issues. A good example of this is the fact that some politicians currently point to a historically low unemployment rate (disregarding the history of changes in the way unemployment is measured) and record levels of people ‘in employment.’ All of this ignores the recent trend towards ‘virtual employment’ – the growth of a ‘gig economy’ based on zero hours contracts and self-employment. We are rapidly creating an underclass of semi-employed, or virtually employed, people earning at or below the minimum wage rate or not earning at all. Food banks proliferate while ‘unemployment’ falls.
From the best of motives, some politicians promise an all-out assault on the emergent employment (mal)practices of the gig economy. Unfortunately, their remedies treat the symptoms rather than the cause, and are thus doomed to failure. The cause is the investment problem and its corollary, the productivity crisis. I am not arguing here against better employment protection, indeed my instinct is to sympathise with those who consider such protection as the hallmark of a civilised society. I am arguing that better employment protection will not create more, better-paid jobs, nor will it increase the tax-base and give the public sector the financial headroom it needs to create those jobs.
Incentives designed to fix the problem have failed. Why?
-Most investment is driven by one thing above all – the expectation of returns. Without that rationale investment does not occur. If we are looking for causes of low investment, then we need to understand some of the reasons for low expectation of returns.
-Low expectation of returns is a self-fulfilling prophecy: lack of investment leads to lower productivity which leads to lower returns and so on in a downward spiral.
– One asset class in particular has tended to outperform all others. ‘Put your money in bricks and mortar’ has been the advice most heeded by savers. ‘The past 20 years or so have been the exception to the historical pattern of inflation-beating but low returns for property. Some factors driving prices are not new: A growing population supported demand, whilst supply was slow to respond. What sets this period from 1995-2017 apart is that investors/speculators held increasingly stronger beliefs that house prices would rise and therefore tried, desperately in some cases, to buy. Banks facilitated this by relaxing deposit requirements and increasing the amount you could borrow relative to your income. On the other hand, low interest rates and rising incomes have made mortgage costs more manageable; the UK household debt to GDP ratio rose from 58% in 1995 to 87% in 2017. With prices soaring, this system has become self-reinforcing.’
– Shortage-driven changes in the housing market have created the dynamic new buy-to-let phenomenon. With activity focused on locations enjoying a higher than average capital growth and rental value, returns from the asset class outstrip any other available to savers. Unfortunately, this does not result in the gains in employment and productivity that other types of investment might deliver.
– Excessive financialisation of the UK economy has created a culture of short-termism. Automated, algorithmic trading of assets offers a faster and better return than long-term ownership of assets that are created by the funding of investment.
– Globalisation of financial markets has advanced to a stage where capital is relatively unhindered in its search for the most attractive returns. The UK has taken a lead in facilitating this process, but its businesses often look less attractive to investors than their foreign rivals.
– The UK has developed a banking culture that does not support investment. Typically, banks do not take equity as security on loans made for investment purposes. They look instead for property as security. As a result the banking sector’s success is not locked into the success of businesses and the economy at large. In extreme cases banks have identified business failure as their strongest incentive. If banks were to take equity in businesses as a matter of course, they would have a strong incentive to keep those businesses alive and to fund future investment.
There is only one course left when incentives fail, direct intervention. We need to create a National Investment Bank with the express (though not sole) purpose of addressing the twin crises in Investment and Productivity. The idea is not a new one. The 2015 Labour Manifesto talked, in passing, of an intention to create a ‘British Investment Bank’:
‘Labour will establish a British Investment Bank with the mission to help businesses grow and to create wealth and jobs. It will have the resources to improve access to finance for small and medium-sized businesses, and will support a network of regional banks.’
By the time of the 2017 Labour Manifesto the commitment had evolved into something more specific:
‘A decade after the devastating international financial crisis, our financial system is still holding back too many of our small businesses and local economies. Labour will transform how our financial system operates. Following the successful example of Germany and the Nordic countries, we will establish a National Investment Bank that will bring in private capital finance to deliver e250 billion of lending power. This new public institution will support a network of regional development banks that, unlike giant City of London firms, will be dedicated to supporting inclusive growth in their communities. The banks will deliver the finance that our small businesses, co-operatives and innovative projects need across the whole country. The National Investment Bank will fill existing gaps in lending by private banks, particularly to small businesses, and by providing patient, long-term finance to R&D-intensive investments. It will also be given the task of helping to deliver our industrial strategy, by prioritising spending in line with its objectives. We will take a new approach to the publicly-owned RBS, and launch a consultation on breaking up the bank to create new local public banks that are better matched to their customers’ needs. Britain has a successful international finance industry, but we also need a strong, safe and socially useful banking system to meet the needs of our own regional economies and communities. We will commit to creating a more diverse banking system, backed up by legislation.’
There are many laudable aims in this policy (although a flat commitment to growth might be more helpful than prioritising ‘inclusive growth’), but experience shows that such initiatives are either too difficult to get off the ground or impossible to sustain:
– Broad political consensus is needed to bring about a NIB’s implementation and longevity. The SNP has a regional plan of its own; while the Liberal Democrats in their 2017 manifesto showed commitment to the idea. In both instances, however, there is a strong question mark in terms of scale and ambition. Any broader political consensus may be hard to find: the unfortunate history of the Green Investment Bank shows that the Conservative party will seek to privatise any such initiative at the first opportunity, and to do so at zero or minimal profit to the public purse.
– There may be a systemic failure of the UK’s political culture that prevents any attempt to address a crisis that threatens to become a national emergency.
All of which suggests that the required response may be, in practical terms, beyond reach. That doesn’t need to be the case, and in a future post I will address the qustion of how it can and should be made to happen.
Meanwhile, it is important to tackle one potentially fatal objection. I have pointed out that investment only occurs in response to an expectation of returns. What if there simply isn’t a sufficiently great expectation for the efforts of a NIB to solve the productivity crisis? Will it merely be pushing on a string? In essence, the future is always uncertain, and in any ambitious, large-sale project, however pressing the need and overwhelming the evidence, there comes a point at which one must simply cross one’s fingers and hope. In this instance that point is the one of cultural change: A NIB needs to be implemented on a scale and at a level of ambition where businesses are led to believe that political commitment to growth, sustained investment and productivity improvement is so strong that a change in expectations is warranted.