I say this is our fundamental economic problem because it is a cause of four things that many people are worried about.
One is low productivity. Output per worker-hour is lower now than it was six years ago. There are many possible reasons for this, but one could well be a lack of new capital equipment.
A second is high unemployment. Investment does not merely – or even mainly – replace workers. It also creates a demand for them, to the extent that it creates new factories and offices. Low capital spending thus means weak demand for labour.
Thirdly is the problem (or perceived problem) of high government borrowing. Think of the economy as comprising three sectors: government, the domestic private sector and foreigners. Because net borrowing must be zero – every pound borrowed must be a pound lent – it follows that if one sector has a financial surplus, others must have a deficit. If companies have a surplus – and foreigners too – it follows therefore that the government must be borrowing. To put this another way, low investment means weak economic activity and thus low tax revenues.
Now, you might object here that I’ve got the causality wrong – that it is government borrowing that has crowded out capital spending. But if this were the case, interest rates would be high. Which of course they are not. This tells us that it is high corporate savings (plus the global savings glut) that has put downward pressure on interest rates and forced the government to borrow. In this sense, low annuity rates are due in part to companies’ reluctance to invest.
For these reasons, any fall in the financial surplus would be a great thing. And this is quite possible in the next few years. Whilst it’s likely that profits will rise as the economy continues to grow, investment might rise even further, thanks to a combination of improved confidence, negative real interest rates (which should increase the relative attraction of physical assets) and replacement demand.
But there’s a problem here. Companies’ financial surplus is not merely a result of the financial crisis. It predates it. For example, whereas firms on average invested as much as they got in retained profits between 1987 and 2001, they invested only 78.7 per cent of their retained profits between 2002 and 2007. In fact, it’s possible that firms’ reluctance to invest was a cause of the crisis rather than a product of it.
This hints at an important possibility – that weak investment isn’t merely cyclical. Instead, despite all the talk of a second machine age and of robots taking our jobs, there has for years been a dearth of profitable investment opportunities. This might be because technical change has slowed down; or because globalization and the internet means innovations are no longer or easily monetizable; or it might be that firms have wised up to the fact that innovative investments have, on average, never been as massively profitable as hoped.
Whatever the reason, the fact is that our economic problems have their origin not in a mere cyclical downturn but in a long-run structural development. Only if or when this changes can we expect a return to the normality of positive real interest rates, low government borrowing and low unemployment.
