Industry | 2010.03.19
UK must invest its way out of recession | Michael Burke
Fixating on the public deficit is distorting the economic debate away from the real issue of plunging investment
Britain\'s deepest recession since the second world war has produced a highly distorted economy. So it is perhaps inevitable that there has been an extremely distorted debate about the how to deal with the consequences of it. Or at least one of the consequences, since the entire debate is focused on just one symptom of the crisis – the public sector deficit .
The economic distortion arises from the fact that the recession has been an investment-led slump. The British economy has contracted by £80bn and the majority of that has been a decline in investment, down £46bn. Individuals\' incomes and their spending patterns have been badly hit, but the 3.6% fall in consumption is completely overshadowed by the 19.3% fall in investment. Unless that lost investment is restored there will be a permanent lowering of the economy\'s growth rate and a permanent loss to competitiveness.
The distortion to the economic debate is the fallacy that the deficit is not related to the decline in activity; that it is somehow a consequence of Gordon Brown\'s reckless spending, or even a collective punishment for profligacy. Nothing could be further from the truth. Without a recession, a continued steady growth of taxation revenues on their long-run trend would have produced tax receipts this year £114bn higher than the Treasury currently expects – of a total current deficit of £128bn. Just as plunging investment is the driver of the recession, so falling taxes are responsible for the widening deficit. An economic policy aimed at boosting investment would not only revive the economy, it would also help to close the deficit.
The latest letter from the EU commission, admonishing the government for its failure to set out a sufficiently bold programme of cuts is a timely reminder that there are strong opponents of fiscal stimulus. This is odd, since almost every industrialised country adopted stimulus measures in 2009. The one exception was the government in Dublin, much admired by the Tory front bench. The admiration seems misplaced: 18 months of spending cuts and tax increases have contributed to the longest and deepest recession in the Euro area. And the policy of "reassuring the financial markets" has been an utter failure even in its own terms. Tax receipts have fallen despite tax rises, and government spending has increased despite deep cuts in both welfare payments and public sector pay. As a consequence, the deficit continues to rise and Irish bond yields have gone from one of the lowest in the Euro area to the second highest, only below Greece .
Despite the obvious verdict from these international comparisons the party of slash-and-burn has many adherents in Britain across the political parties and inside the Treasury. This too is an oddity, since the Treasury\'s own long-standing research shows not only how investment can revive activity, but also how government investment actually produces a positive return, which could be used to pay down debt or boost other spending programmes.
The first of these is the Treasury Public Model, which shows a rising \'multiplier effect\' from government spending, Annex, page 102 . It shows that for every £1bn spent by government there is a much larger economic impact: £1.1bn in the first year, rising to £1.4bn in both the second and third years. This is a bigger stimulative impact than cuts to either direct or indirect taxation.
The second piece of long-neglected Treasury research is its own "ready-reckoner" – Public finances and the cycle: Treasury economic working paper No 5, November 2008 . This estimates two effects on government finances from a change in GDP. The first is the improvement in tax receipts and the second is the reduction in government spending (lower welfare payments and so on). Taken together the ready-reckoner estimates that for every £1bn improvement in the economy, 75% of that will feed through to an improvement in government finances in the second year. So a £1bn increase in government spending leads to a £1.4bn increase in activity, which produces an improvement in government finances of £1.05bn. This is a positive return, which can be sued either for deficit reduction or further investment.
Even these are likely to be underestimates in the current situation. The Treasury\'s analysis is based on estimates of long-run averages, which include both booms and busts. At the end of the current extreme recession, there is unusually large spare capacity in the economy, and an unusually large collapse in tax receipts. In addition, the Treasury analysis focuses only on general government spending, not investment. Most research in this area is agreed that investment has a far bigger multiplier attached to it than general government spending. Getting those trends to work for us, and getting people back to work and paying taxes is the only sure way to reduce the deficit. The government can invest its way out of recession.
For more information, please visit
http://www.guardian.co.uk/commentisfree/[...]sion-public-deficit-investment
