Saturday, November 23, 2013
Cash has been king for long enough: now for some investment
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The figures for business investment do not get the same attention as those for gross domestic product, unemployment and inflation.

Business investment is, however, important and in three days' time we will get the figures for the third quarter. An investment-led recovery is the prize for policymakers. A recovery driven by investment and exports is the holy grail.

So far investment is not delivering and exports, while they have grown in recent years, have been neutralised in their economic impact by rising imports.

The Bank of England’s monetary policy committee, in its latest deliberations, said “a successful handover from household to business spending would play a crucial role in underpinning the recovery in the medium term”.

The previous set of official figures, for the second quarter, showed whatever else we have been having it has not been an investment-led recovery. Business investment was down by 2.7% on the quarter and by 8.5% on a year earlier. It was more than 25% below its pre-crisis peak.

Growth in the economy has surprised on the upside this year but investment has done the opposite, so much so the Bank questions the figures, pointing out initial estimates are “prone to large revisions”.

Even such revisions may not change the picture fundamentally because it is not purely a British phenomenon. The Paris-based Organisation for Economic Co-operation and Development (OECD) noted last week that “business capital spending has been subdued in recent years, even allowing for soft demand growth.”

This is not supposed to happen. We expect businesses to anticipate upturns, or respond quickly to them, turning a modest increase in demand into something stronger. Economists used to spend a lot of time analysing this accelerator effect.

In recent years, business has been happier to wait and see, to sit on its hands until the outlook becomes much clearer. In the past, that would have been a recipe for allowing competitors to steal a march.These days the game has changed.

I’ll return to that. But if you wanted reassurance the investment train had been delayed but not cancelled, you would draw on two factors.

One is that firms have been deterred from investing by economic uncertainty. The banking crisis, followed by the eurozone crisis, with any number of other crises running in tandem or threatening to break out, has been a powerful dampener on corporate investment ardour.

The other is that damage to the banking system (and its extreme lending caution) has deprived new and expanding businesses of the finance they need to expand.

Most investment is done by larger firms but to the extent smaller businesses have been deprived of funding, this has been a factor, not just in weak investment but also poor productivity growth. The “creative destruction” economies need after recessions has been held in check.

The good news is that both of these factors are easing. The Bank’s MPC cites evidence from its agents that economic uncertainty is fading fast as a constraint on investment. A year ago a net 50% of firms cited uncertainty as a factor dragging on investment plans. Now it is 5%.

The optimistic view would be that as the clouds of uncertainty lift, so will investment. Business confidence is up, as so is the outlook (the latest CBI survey showed the strongest growth in manufacturing since 1995), so investment should follow.

Availability of finance, similarly, is not what it should be but showing signs of improvement. We have just seen the first tentative rise in bank lending to small and medium-sized firms since 2009.

These are two good reasons to think we might start to see an upturn in business investment. We will see this week whether it is too early for that to show in the official figures. There are, though, gloomier views. One is that the incentive structures within firms are biased against investment.

Chief executives have relatively short time horizons. Most last longer than football managers but not that much longer, with an average tenure of 3-4 years. In that time they get plaudits from shareholders for increasing dividends or buying back their own shares. This, in turn, pushes the share price higher, on which the chief executive’s bonuses are usually based.

This is not to say chief executives undertake no investment. Plainly they do, even if the benefits will be felt by their successors, But they do not do as much as they should.

The other argument is that there are not enough good prospects for businesses to invest in. An influential paper last year by Professor Robert Gordon of America’s Northwestern University, asked the question “Is US economic growth over?”.

His deliberately provocative title was to discuss whether, temporarily or permanently, America - and by extension other advanced economies - were in a prolonged quiet phase for innovation.

The IT and telecommunications revolution, the latest of the innovation waves that date back to the industrial revolution, has on this view run most of its course.

As Gordon put it: “Many inventions that replaced repetitive clerical labour with computers happened a long time ago, in the 1970s and 1980s. Invention since 2000 has centred on entertainment and communication devices that are smaller, smarter, and more capable but do not fundamentally change labour productivity or living standards in the way electric light, motor cars, or indoor plumbing changed it.”

Many reading this will argue that we have barely begun to scratch the surface of the possibilities of new technology. Others would argue that the changing economy means we should think of investment differently. When manufacturing dominated, business investment was big and tangible: plant and machinery, new factory buildings and so on.

Now it is different, so we should think of investment as less tangible. The Office for National Statistics will next year incorporate intangible investment, including goodwill, into the GDP figures. We should also think of it as investment in people - recruitment and training - strong even as traditional investment has been weak.

We should not think, as some suggest, of government investment as an alternative to business investment. The two are fundamentally different. Government investment, in for example infrastructure, can help create the conditions under which the private sector can invest and grow. Rarely can it be a substitute for it.