Their optimism is founded in large part upon the belief that business investment will rise sharply; the OBR expects a 27.5 per cent rise in this between 2014 and 2016, and the Bank expects a 43 per cent rise.
However, Bank of England figures this week show that bank lending to non-financial companies is still falling. It dropped by £7.8bn (two per cent) in the first two months of this year.
This matters, because as you might imagine, there has traditionally been a correlation between lending and investment: rising capital spending in the late 90s and mid-00s was accompanied by rising lending, and the slump in investment after 2008 saw debt repaid. This poses the question: can business investment really rise as much as the Bank or OBR expect if firms are repaying debt?
There’s one reason to think so. Non-financial firms have built up massive cash piles. They now have £289.5bn of sterling deposits in the UK – equivalent to over two years of business investment. Companies could both step up investing and repay debt simply by running down these cash balances.
Equally, though, there’s a reason to doubt they’ll do so. Firms have accumulated cash precisely because they haven’t seen any decent investment opportunities. Why should this change?
In this context, thinking about “firms” in aggregate is misleading. What matters is variation between them. Think of companies as being distributed along two curves. Curve one is their cash holdings: some are cash-rich whilst other (generally smaller and newer) ones have little cash. Curve two is the range of investment opportunities: some firms can see profitable investments; others can’t. Now, if these two curves coincide, we’ll get an investment boom because there’s a match between opportunities and cash holdings. But if they don’t, investment will stagnate or worse because firms with cash won’t see how to invest it, whilst those with investment opportunities might not be able to raise finance.
Sadly, though, data about firms in aggregate don’t tell us what we need to know – which is the degree of overlap between cash and opportunities. This is one reason why business investment has traditionally been hard to predict.
What’s more, even if we do see a big rise in business investment, this won’t be a reason for unalloyed rejoicing.
One danger is that if the investment is dominated by cash-rich firms – as it must be if lending continues to fall – then bigger, mature firms are likely to grow at the expense of newer, smaller, credit-constrained ones. This could increase the degree of monopoly and diminish competition.
There’s another problem. Why should companies that have accumulated cash suddenly see investment opportunities this year? It might be that what changes is not so much the number of genuinely profitable projects but rather companies’ sentiment. Just as economic growth causes equity investors to become more risk-tolerant and hence to invest in bad stocks, so it can also cause companies to become overconfident and to invest in bad projects. History tells us that this is a big risk. Charles Lee and Salman Arif have shown that, in most developed countries, periods of high capital spending are followed by disappointing corporate earnings, falling share prices and weaker economic growth.
