The National Investment Corporation: Some Reaction
I’ve been advocating some form of NIC for months now, but I’m glad to see that I’m not the only one welcoming the proposal.
The ‘Director of Finance’ magazine blog adds some good historical context.
…it looks very like the old ICFC, the Industrial & Commercial Finance Corporation set up by the Labour government in 1945 to provide finance for small firms. It was funded by the newly-nationalised Bank of England and the main clearing banks, which had their arms twisted by ministers. In the days before private-equity, ICFC was the largest provider of venture capital to British companies.
There was a sister organisation for larger companies – Finance Corporation for Industry – and the two merged in 1983 and became Investors In Industry, now known as 3i and still a major provider of capital to small companies despite its own stock market flotation.
The 1970s government also created the National Enterprise Board to direct finance to firms that could not find it elsewhere. And even this current Labour administration has set up a £1bn innovation fund to direct finance to small firms.
The new NIC is an old idea reworked therefore, but there’s nothing wrong with that if history showed the idea worked previously. And there is clearly demand for small-firms finance: if the privately-owned banks won’t provide it and the publicly-owned banks wont either, then direct government funding will be welcomed by business.
On the surface this seems like a good idea. Britain has plenty of areas of world-leading expertise – particularly, as Brown mentioned yesterday, in low carbon technologies – and any measures that reconcile the twin aims of a low carbon future with domestic economic growth are to be applauded.
The EEF (a manufacturers’ group):
If today’s announcements build on the extension of the scrappage scheme and are designed as a more active approach to supporting industry then they will be welcomed by manufacturers. However, business will be looking to the National Investment Corporation to make a fundamental change in how innovative companies can access the finance they need to grow.
David Wighton’s business column in the Times:
Whatever the banks say, there does seem to be a problem at the moment for businesses that cannot get bank finance but are not big enough to take advantage of the buoyant share and bond markets.
Some private equity executives have expressed concern that the new fund might cherry-pick the best investments, squeeze them out and not provide any net increase in funding. But a well-designed scheme should avoid that.
Brown’s Speech
I don’t have time today to do a full analysis of Brown’s speech. But in general I liked it.
In the economic sections he concentrated more on future growth and less on the fiscal situation, that’s sensible. On a simple word count “investment” was mentioned five times against “deficit” only getting four.
I’m intrigued by the idea of a National Investment Corporation and will await full details.
But best of all was the line, “Finance must be the servant of people and industry and not their master.” Which I believe is drawn from the Party’s 1944 “Full Employment and Financial Policy”. If only he’d quoted the whole section…
Blame for unemployment lies more with finance than with industry. Mass unemployment is never the fault of the worker; often it is not the fault of the employers. All widespread trade depressions in modern times have financial causes; successive inflation and deflation, obstinate adherence to the gold standard, reckless speculation, and over investment in particular industries…
The view is now widely accepted outside the ranks of the Labour Party, by most economists, by many Government officials, by many businessmen, even by some bankers…
Finance must be the servant, and the intelligent servant, of the community and productive industry; not their stupid master.
Good Economic Reads
A few bits and pieces.
Caroline Baum’s Bloomberg article on bond market traders is a must read for anyone who blandly talks of ‘the market’ when discussing gilts/public borrowing.
Willem Buiter has a typically long, detailed and interesting discussion on why QE is failing.
Paul has a great article up on the power of ratings agencies.
Free Thinking Economist on how cutting the deficit can increase the debt.
And Left Foot Forward report Paul Krugman defending deficits and discussing the collapse in investment.
Investment down 21.8%
A timely reminder on the state of investment in the UK comes from the ONS this morning.
Business investment for the second quarter of 2009 is estimated to be 10.2 per cent lower than the previous quarter and 21.8 per cent lower than the same period last year.
I continue to be amazed that collapse in investment is not being debated whilst the size of the deficit is. The real threat to Britain’s economic future is a lack of investment, not increased public debt.
1976 and all that
I’ve been reading quite a bit of economic history over the last few months and overl the last few days I’ve been re-reading ‘Good Bye Great Britain: 1976 IMF Crisis’ by Kathleen Burk & Alec Cairncross.I really would recommend it.
It is especially strong in putting the crisis into international perspective – the response of the US and German governments to Britain’s problems was as important as our own government’s. What is striking is the extent to which US Treasury Secretary William Simon, about as free market as Treasury Secretaries come, used the IMF as weapon to force a policy shift in the UK.
Aside from the international context there are some important points, relevant to today.
Last year’s large fall in Sterling is not really comparable to the situation in the 1970s. The external debt position of the UK economy is much stronger and now, as then, Sterling was falling from an overvalued position. Perhaps most importantly Sterling is not the reserve currency it then was and there aren’t ‘Sterling Balances’ held by mainly Commonwealth countries and oil exporters that can suddenly flee.
The other major difference is the inflation situation. 1976 was a crisis characterised by high inflation, the current economic problem is characterised by low inflation. This makes the required response very different.
The Callaghan ‘you can’t spend your way out of recession’ speech is often quoted by the right now, aiming to ‘prove’ that last year’s fiscal stimulus was a bad idea. It’s important to get the context right. The speech was far more aimed at appeasing American opinion than at a domestic audience – President Ford apparently congratulated Callaghan on ‘a helluva speech’. Callaghan himself later stated that he was never arguing against deficit financing in a recession.
Figures, forecasts and statistics can be wrong. Estimates of the PSBR (public sector borrowing requirement) were widely off the mark in 1976/77. The result was that Healey tightened fiscal policy far more than was necessary. What will be the deficit in 2010? I honestly don’t know, probably a large one but to start making judgements and allocating cuts now based on such an imprecise estimate risks repeating the same mistake.
The Cabinet in 1976 was fully aware that the public spending cuts would damage the economy. Benn from the left articulated the Alternative Economic Strategy as a response (actually much praised in Andrew Gamble’s work), Crosland instead argued for increased spending and possibly limited import controls. The failure of the Crosland and Benn camps to unite is a great lost opportunity.
In the end the Cabinet surrendered to ‘the markets’. Monetary targets and spending cuts (plus asset sales) were accepted purely to appease market opinion. The result was a deeper recession and the breaking of the social contract that led, indirectly, to the winter of discontent.
The simple fact is that market opinion is changeable and often wrong. In 1976 the Government backed down rather than fighting. I worry we are being pushed into making the same mistake today.
What recovery?
The chart below shows monthly US GDP.
It does rather beg the question… what recovery?
(Via Alphaville)
Labour Investment versus Tory Cuts
I’m bored of the public spending ‘debate’. There are two issues which have been entirely conflated. First, was the Government right to launch a fiscal stimulus rather than aim to minimise the deficit, a la Ireland, last year? I think most sensible commentators now accept that the Government was correct. Second, a what point should the stimulus be withdrawn? Here we can have a genuine debate. I stand with Krugman (and I’ve dubbed the ‘crazy people gang’) that next year is probably too early. It all depends on when the long awaited ‘recovery’ begins. Or at least it should, but Cameron now appears to be embracing an ideologically driven, economically illiterate position.
But I want to turn to bigger issues. A while back Hopi asked:
So surely the biggest question in politics should be “What should we do to grow”, rather than “How and what do we cut”? The general consensus seems to be that recovery will be anemic and tentative, no matter what the official projections are. So why do so few politicians appear to have a coherent argument about how we can do about changing that?
Obviously, I’d be positively enthralled by a social democratic argument about what the role of the state was in priming short to medium term growth.
Chris Dillow responded by writing:
Of course, it’s easy enough to boost short-run growth – just throw enough money around. Promoting long-run sustained growth is, however, much trickier. It might even be impossible. This paper concludes:
“Except for the decades around WWII, there is no evidence of country specific effects on long run growth rates…Growth rates are determined by international factors, and are insensitive to national policies, especially for small countries. This implies severe restrictions on the ability of most governments to increase national long run growth rates.”
He used the examples of France, Italy, Spain, Sweden, UK and the US to illustrate this point. Although late, in the comments, when asked about Japan and South Korea he noted:
Policy and institutions matter enormously for whether poor countries catch up with the rich or not. It’s just that once freeish markets and secureish property rights are in place, and a country is near the technological frontier, the ability of policy to increase long-run growth seems to diminish a lot.
I’m not sure I agree. John Ross has made a convincing case that China’s growth model has universal characteristics that can be replicated. As he wrote last month for the Guardian :
China has a series of interconnected and mutually reinforcing policies.
The first is the economy’s high proportion of exports – crucial to its “opening” process. Every economist since Adam Smith has known that the division of labour is a decisive lever in raising the level of productivity, and division of labour in a modern economy is necessarily international. A high level of exports and imports is the way of participating in such a division of labour – as well as benefiting from advantages such as economies of scale.
Economic theory therefore confirms what economic practice already demonstrated. That the alternative to China’s open approach, that of inward-looking “import substitution” policies lead to inefficiency in capital use and low productivity.
Critics of China’s “export-led growth” confuse two ideas. The first is a high level of exports in GDP, rightly integral to China’s growth model, the second is a high trade surplus – not integral to China’s model, which appeared only after 2005, and is now disappearing rapidly.
Second is China’s high level of investment. Modern econometric research shows conclusively that, following division of labour, the largest element in economic growth is the growth of fixed investment. This applies not only to a developing economy such as China but also to developed economies. Dale Jorgenson, the world’s leading expert on productivity growth, notes that “investment in tangible assets is the most important source of economic growth in the G7 nations. The contribution of capital inputs exceeds that of total factor productivity for all countries for all periods.”
Criticisms of China’s high level of investment would be valid only if China used that investment inefficiently, and contrary to claims made without evidence, all studies on productivity show that China uses that investment with an efficiency rate from respectable to high (pdf).
Third, a decisive point showing China has a “socialist market economy” and not “market capitalism”, is its method of macro-economic regulation. (My emphasis).
The second point here – investment – is crucial. Investment in the UK economy has collapsed Taking the most recent ONS estimate:
Gross fixed capital formation fell by 4.5 per cent, following a fall of 7.5 per cent in 2009 Q1. There were sharp falls in business investment on machinery and equipment.
The level of gross fixed capital formation is now 15.2 per cent below the same quarter of 2008.
The 15.2% drop in investment is the single largest driver of the fall in GDP. What’s more this has more than a short run effect. As John notes the work of Dale Jorgenson (former head of Economics at Harvard) suggests that investment is the driver of long term growth.
So rather than talking about the deficit, shouldn’t we be talking about the level of investment? Given it’s the biggest contributor to the recession and arguably the driver of long term growth?
How though do we go about raising investment? Ultra low interest rates and quantitative easing alone haven’t achieved it (although they have probably prevented an even worse fall).
As John has noted, Keynes dealt with this very issue.
Keynes noted in the final chapter of his General Theory, in a point highly relevant to a situation where mass unemployment is again soaring, that “a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment”.
I’m not advocating a command economy, I’m not advocating nationalising the commanding heights of industry. I’m simply arguing for direct public intervention to raise investment levels. In the short run this will raise GDP and in the long run it raises trend growth. It’s not even thst radical – it’s just a Keynesian solution.
If we embark on this policy then we can truly fight on the grounds of ‘Labour Investment versus Tory Cuts’.
Public Spending & the ‘Crazy People’ Camp
I want to echo Richard Murphy in agreeing with Adam Lent’s excellent post on spending cuts.
Cuts are dangerous; a major programme of cuts risks forcing the UK back into recession and damaging our economic prospects for a generation. It doesn’t take much economic nous to recognise that sacking tens of thousands of public sector workers and reducing the amount of money the state spends in the wider economy will increase unemployment, increase bankruptcies and other financial difficulties for companies and will reduce demand and further constrain bank lending.
This is, of course, bad enough in itself. But there is a further threat. If the UK struggles on under recssionary conditions while other economies grow, we will not be able to seize global market share and we will not be able to attract new investment. The result will be a UK economy back in the doldrums for years just as it was in the 1970s and much of the 1980s – the “sick man of Europe”.
This is a much greater threat to our well-being and the future prosperity of our children and grandchildren than public debt. Asia is emerging from this recession far quicker than Europe and America. China is expected to post a stunning 8% growth soon despite the global crisis. If we take shallow economic decisions now, the UK will be left behind as the new economies rush past us in the innovation, productivity and investment stakes.
Agreeing with Adam puts myself and Richard in what Paul Krugman has dubbed the ‘crazy people’ camp.
There’s a tendency to treat worries about a double dip as outlandish, as something only crazy people like the people who, um, predicted the current crisis worry about. But there are some real reasons for concern. One is that the lift from fiscal stimulus will start to fade out in a couple of quarters. Another is that, as Yellen points out, most of the boost we’re getting now is tied to inventories. And that’s a one-time thing.
As I’ve argued for the past few months the ‘recovery’ we are seeing is driven by base effects and an inventory build up. Unemployment is still rising.
The Osborne line, that cutting the deficit will lead to lower interest rates and hence more private investment, is an extreme form of Rubinominics.
Rubinomics emphasizes the effect that balancing the government budget has on long term interest rates. Taxes should match government spending in the long run, and deficit-financed tax cuts are an ineffective way to increase growth. This can be seen as a form of the fiscal theory of the price level – fiscal policy affecting long term inflation (as expressed by long term interest rates).
Rubinomics has never rejected Keynesian approaches to economics, which call for the government to run a deficit in times of recession.
As the Wall Street Journal wrote last year:
Rubinomics never did have much economic basis, and even casual observation over the last 25 years has exposed its illogic. As deficits rose in the 1980s, interest rates fell. In the current decade, deficits rose and interest rates fell for a time, then later deficits fell but interest rates rose.
Even in the 1990s, the facts never matched the theory. The rate on the 30-year Treasury bond did fall in 1993 amid the Clinton tax increases, but it slowly climbed again throughout 1994. The historic market turn — in stocks and bonds — came exactly on the day in 1994 that Republicans won the House of Representatives for the first time in 40 years. Interest rates move up or down based on multiple variables, such as monetary policy and global capital flows.
Mervyn King spoke yesterday about the UK economic outlook – broadly put is forecast is low growth and low inflation.
Clearly a slower recovery implies worsening public finances and, according to Osborne’s logic, higher interest rates.
Yesterday the yield on UK two year bonds hit a record low.
Blanchflower, Brown, Japan & Recovery
Danny Blanchflower’s article in the New Statesman is a must read.
The former MPC member writers that:
The risk of a long-lasting economic depression is not over. There have been some positive signs recently, and the worst may be behind us – but we should not get too carried away. Retail sales have risen a little and there are some positive signals from the housing market. There was even some evidence of positive GDP growth in France and Germany. Nonetheless, in the United Kingdom, money supply growth remains weak, banks are still not lending and mortgages are hard to come by. The latest surveys for construction and manufacturing still show contraction. Negative equity is on the rise, as are mortgage defaults. Unemployment is climbing fast and a million jobless young people under the age of 25 are in danger of becoming a lost generation.
One year on from the financial crash and the ensuing recession, the question remains: how did we get into this mess in the first place? In my view, and as I have consistently argued over the past two years, the economy would have been in much better shape today had the Bank of England’s Monetary Policy Committee (MPC) – on which I sat as an external member for three years until 31 May – not kept interest rates so high, especially from the beginning of 2008. House prices had peaked by the end of 2007 and business and consumer confidence surveys had collapsed. By the second quarter of 2008, based on both output and employment, the UK economy had moved into recession. But my colleagues on the MPC did not join me in voting for rate cuts until October 2008.
And he lays much of the blame at the feat of Governor Mervyn King.
In fact, it was in late 2007 that I became convinced there was much more slack in the economy than others on the MPC believed. Starting that October, at monthly meetings of the committee, I started voting for rate cuts, something that continued through every meeting in 2008. The collapse of Northern Rock had shocked me, and in January 2008, I warned in a Guardian interview that my MPC colleagues were “fiddling while Rome burns”.
In the summer of 2008, I warned the Commons Treasury select committee that “something horrible” was going to happen. I was becoming even more worried about recession, and in September I voted alone, as ever, for a cut of 50 basis points (bps) – or 0.5 per cent – to the Bank’s base rate. At my September appearance before the select committee, King, who was sitting two seats from me at the time, was asked by the MP Andy Love: “On unemployment there have been some suggestions, and Mr Blanchflower has said – and I think there are quite a lot of people out there who would agree with them – that it may go up faster than the projections in the Inflation Report. Is that a worry to you?”King replied: “At least the Almighty has not vouchsafed to me the path of unemployment data over the next year. He may have done to Danny, but he has not done to me.” To say the least, I was rather surprised.
He also makes strong criticisms of the Bank. An attack that the Tories should take very seriously indeed given their plans to give the BOE more power.
Throughout this crisis the MPC needed the advice of experienced bankers, lawyers, businessmen and market-watchers. Unfortunately, practical folk who knew how to spot and cope with banking crises were in short supply at the Bank of England. There were too few regulators on the staff. Instead, the Bank was stocked full of mathematical modellers who had never seen the inside of a commercial bank or a hedge fund – and the models they used failed to pick up on the greatest financial crisis in a century. Yet, in my view, it was clear from roughly six months before the Lehman’s crash in September 2008 that a financial tsunami was heading our way from the United States.
He does end on a more positive note:
In recent months, however, there has been a sudden transformation at the top of the Bank of England. Mervyn King’s support for a bigger boost to QE shows he now understands what has to be done to tackle this crisis. This makes a pleasant change for me, as I have spent the past three years criticising his decisions.
Danny got things right from 2007, and was sadly ignored. One year on from Lehman’s and people now seem convinced that we have a ‘recovery’. That we can start ‘cutting’ public spending. Japan’s lost decade, the peril we aim to avoid, is instructive.
It wasn’t a sudden crash followed by a return to growth.
(Hat tip Alphaville)
As Anthony Painter writes today:
The most ridiculous aspect of this situation is that we have a historical example at hand of what can happen should fiscal policy be retrenched too early. As it happens, it is better to err on the side of incaution following a large explosion of an asset price bubble. That example? Japan in the 1990s and early 2000s.
As Richard C. Koo has written:
“There are few things as dangerous as premature attempts at fiscal consolidation during a [balance sheet] recession.”
A balance sheet recession is characterised by a major decline in demand for debt following the bursting of an asset-price bubble. The credit crunch had the potential to become such a recession and would have done had not a strong mix of monetary and fiscal stimulus been undertaken. And it could still happen.
How do we know? Well, fearing a ballooning Japanese deficit – a consequence of the bursting of share and property bubbles in the early 1990s – the Hashimoto administration decided to retrench Japanese government spending in 1997. What happened? The economy plummeted into the worst post-war meltdown and a credit crunch was precipitated. Tax revenues collapsed and the budget deficit soared – so much for fiscal consolidation.
Just to make sure we received an absolutely clear message should our own economy be beset by similar issues, the Japanese government tried the trick again in 2001 under Prime Minister Koizumi (who saw himself as a kind of Japanese Ronald Reagan/ Margaret Thatcher hybrid.) He placed a cap on the deficit.
The result? Tax receipts shrank, the budget deficit increased, and the target was dropped at risk of crippling the economy once more.
Brown’s speech today was much better than I feared.
“We are doing the right thing to make sure that for the future as we move into a full recovery we will invest and grow within sustainable public finances – cutting costs where we can, ensuring efficiency where it’s needed, agreeing realistic public sector pay settlements throughout, selling off the unproductive assets we don’t need to pay for the services we do need.”
In the wide-ranging 35-minute speech on the economy he also said he would be “demanding that internationally we look at setting limits on city bonuses”.
He said, “when the recovery comes” a Labour government would “continue to raise the minimum wage every year” and got a round of applause from union delegates when he said he would be “arguing that we should implement a blacklist on uncooperative tax havens”.
…
He said: “The choice is between Labour who will not put the recovery at risk, protect and improve your front line services first and make the right choices for low and middle income families in the country.
“And a Conservative Party which would reduce public services at the very time they are needed most, make across-the-board public spending cuts to pay for tax cuts for the wealthiest few, and make different choices about public services because they have different values.
“These would be the wrong choices at the wrong time for the wrong reasons because they have the wrong priorities for Britain.”
I’d be happier if we spoke of tax rises as well as spending cuts.
But the message is becoming clearer. The Governor of the Bank of England seems to (belatedly) ‘get it’. Gordon Brown ‘gets it’. The biggest risk to any recovery now is an ideologically driven Tory programme of cuts.
The Tories, the debt and ‘the markets’
Paul noted recently that Philip Hammond got a little confused on TV.
Hammond was trotting out the new Tory line that we need to be tough on spending to appease ‘the markets’.
Last autumn, around the time of the stimulus package, the right wing line was that this would cause the markets to stop funding the UK government or that Sterling would ‘crash’.
The same lines re-appeared around budget time.
Sadly for the Tories, the crash didn’t happen. So now, with a wonderful twist, they are peddling the line that the only reason ‘the markets’ haven’t lost faith in the UK is the prospect of a Tory Government.
In this were the case (that the markets were happy lending to the UK, due to the prospect of a Tory regime) the cost of borrowing would surely be related to the likelihood of a Cameron government.
The chart below does indeed show some correlation.
Are the Tories right then? Not really. Not unless the prospect of a Tory government is somehow holding down US bond yields too:
Cameron/Osborne/Hammond might be really into cutting, but I doubt they’ll make much impact on the US Federal Deficit.
There are a vast number of factors that determine yields – the expected rate of inflation, the likely course of short term interest rates, the perceived strength of the economy, the attractiveness of other assets – not to mention technical reasons such as pension funds matching their liabilities to long term, stable assets.
The Tories either know this and are being willfully dishonest or they don’t. Which would be kinda scary.
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