Duncan’s Economic Blog

The Unlikely Investment Boom

Posted in Uncategorized by duncanseconomicblog on August 5, 2010

George Osborne tells us he wants a “new economic model” based on “long term saving and investment.”.

The OBR has reassured him he’ll get it – with an investment boom due to arrive over the next five years. I’m more sceptical.  

In the Budget, the OBR was explicit about why it is forecasting this boom (my emphasis):

“C.24 Business investment is forecast to pick up during 2010, though in the year as a whole it rises by only 1½ per cent. The recovery is maintained in 2011, although it takes until 2013 before investment returns to its prerecession peak. From 2011 onwards business investment rises at rates between 8 and 11 per cent.

C.25 The measures to reform corporation tax, which are estimated to reduce the cost of capital faced by firms by about 3 per cent, should have a positive effect on investment. The introduction of the bank levy may partially offset the fall in the cost of capital should banks pass on some or all of the levy in the form of a higher cost of corporate finance. Even this partial offset is likely to be moderated to the extent that the levy is reflected in lower bank profits and remuneration.

C.26 Business investment growth is higher than in the pre-Budget forecast as the boost from the lower cost of capital feeds through. Business investment also strengthens as resources released from the government sector flow into the private sector. The level of business investment is around 1 per cent higher in 2014 than in the pre-Budget forecast.”

The Government then (both the Chancellor and his OBR) appear to believe that reducing the cost of capital will lead to higher investment, which is a statement straight out of neo-classical macroeconomics.

In reality of course, the cost of capital is one factor amongst many that business people must weigh up when deciding whether or not to invest. And the cost of capital also depends upon the rate at which one borrows, rather than simply the level of tax levied on future profits, let alone considerations of pesky things like capital allowances (which they have cut).

The Chart below compares business investment to Corporation tax from 1980 to 2009 – which the OBR seems to think is the decisive factor.

I’m far from convinced that we’re about to experience an investment boom…

5 Responses

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  1. Left Outside said, on August 5, 2010 at 12:50 pm

    A bigger factor will be how good business is expected to be in the long run, with a non-trivial chance of a lost decade in Europe and the US I’d say now is a very difficult time to say it is a good time to invest. Govt’s are contrained from boosting demand, and Central banks are, while not seeming to undermine fiscal action, refusing to augment it and counteract it.

    Tax seems a minor concern, if business is good then a % here or there of tax isn’t decisive, same when business is bad.

  2. dannyboy said, on August 5, 2010 at 2:10 pm

    well big business is sitting on oodles of cash (the mirror image of the household sector situation) so if its not an investment boom then its nothing.

    but on the flipside, with a flat yield curve – what’s the point?

    • vimothy said, on August 5, 2010 at 2:36 pm

      Mirror image of *govt* sector. Well, almost.

  3. Chris Cook said, on August 5, 2010 at 5:08 pm

    Haven’t seen you on Labour List for a while.

    There’s a big difference between the cost of capital for financing development of new productive assets and the cost of long term funding of completed assets, where investors are queuing up internationally for a secure. low risk real return ANY real return.

    I agree with Buiter and Taleb that if debt is unsustainable, we need a new approach to equity for financing and funding, and that’s what I outlined on Labour List the other day.

    http://www.labourlist.org/funding-the-big-society

    If council and housing association debt; education and health PFI debt; transport debt (eg Network Rail) and other infrastructure debt were refinanced using a ‘unitisation’ approach the result would be to release literally tens of billions of development credit.

    The reason is that by using such ‘Public Equity’ there is no repayment of debt principal, and no compound interest, but there IS a secure, low risk (because affordability = certainty) – dividend ultimately based on land/location rental value.

  4. […] preferred strategy is simply to cut corporation tax and hope for the best. Something I feel is unlikely to work. Especially when it has been largely funded by slashing investment […]


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