The economy in 2013

First, when companies are spending on capital equipment, they usually hire more labour too; in practice, capital and labour are complements more than substitutes. If corporate spending rises, therefore, so too will household incomes. And this increases the chances of consumer spending picking up.

Second, over longish periods, there is a positive correlation (0.34 for three-yearly changes since 1980) between business investment and real equity returns. Granted, one reason for this is that higher share prices encourage more investment. But a bigger reason is simply that the circumstances in which companies are confident enough to spend more are also circumstances in which investors are confident enough to bid up share prices. If equity investors are to see good returns over the next few years, therefore, it will greatly help if capital spending rises.

Third, the public finances depend heavily upon corporate spending. There's a simple reason for this. Across the whole economy, net borrowing must equal net lending (this seems trivial, but it's astonishing how many people seem not to know it). If one sector is a net lender, therefore, another must be a net borrower. In recent years - since before the crisis but that's another story - companies have been big net lenders; their retained profits have exceeded their capital spending. The counterpart to this is that someone must be a net borrower. That someone is usually the government. Weak corporate spending causes a weak economy, which means lower tax revenues and higher welfare spending and thus a budget deficit.

This implies that corporate investment must rise if government borrowing is to fall significantly.

Granted, it's theoretically possible for government borrowing to fall if other sectors become borrowers, but in practice this is unlikely. Foreigners are unlikely to become borrowers from the UK - that is, our current account is likely to remain in deficit - given the fiscal austerity in the eurozone and Asian economies' high savings propensity. And the household sector is unlikely to borrow heavily, given its high debt levels and lack of confidence.

The fate of the economy, therefore, hinges heavily upon the prospects for corporate investment.

And here, you might think, are reasons for optimism. In recent years, companies have done a lot to repair their balance sheets. Bank of England figures show that since September 2008 non-financial companies have repaid £87.3bn of bank debt. And with interest rates negligible, they have little incentive to cut borrowing more or add to their £259.1bn of sterling bank deposits. Surely, then, they are well-placed to step up capital spending.

There's a problem with this thinking, though. It told us to expect a big rise in capital spending this year and last year. But this didn't happen. If we must be optimistic about capital spending, then, we need other reasons. Luckily, there are some.

First, it's possible that uncertainty will decline in 2013. A resolution of the US's 'fiscal cliff' should clarify the outlook for overseas demand - better still would be some clarity about the eurozone crisis - and it's possible that the forthcoming Energy Bill will resolve some uncertainty about a crucial sector of the economy.

This matters. Real options theory tells us that uncertainty holds back investment spending. Just as financial options are more valuable the greater is the uncertainty about the underlying asset, so options to invest in new projects are more valuable, the greater is the uncertainty surrounding them. High uncertainty thus encourages companies to hang onto their investment options rather than exercise them.

Researchers at Stanford University have corroborated this theory. They've found that uncertainty about economic policy - one of the few aspects of uncertainty that can be quantified - is indeed bad for growth. "Increases in economic policy uncertainty foreshadow declines in output, employment and investment," they've concluded.

A second reason for optimism lies with the Funding for Lending Scheme which, it is hoped, will boost bank lending to small companies. Now, you might think this is a weak stimulus simply because few companies are starved of finance. A recent survey by the CBI of manufacturers - a sector that rarely cheers its access to cheap money - found that only 6 per cent cited a lack of external finance as a constraint on investment. But a few companies can make a big difference. If companies which account for 2 per cent of overall capital spending were to double their investment, then spending would rise by 2 per cent - which is a substantial amount given that investment growth has averaged only 2.8 per cent a year in the last 30 years. Remember, economic upswings and downturns are about what happens to minorities of companies, not just about average experience.

A further reason for optimism lies simply in the fact that the decline in capital spending has been going on for so long. Although the volume of business investment in the third quarter of this year was 14.8 per cent above its 2009 trough, it was still 12.3 per cent below its pre-recession level. This could mean that there's lots of pent-up demand to replace outdated equipment or upgrade software. Sadly, though, these reasons aren't overwhelming. There remain two enormous drags upon corporate spending.

One is that the weakness of the economy means that most companies have spare capacity and so don't need to expand. The CBI has found that 89 per cent of manufacturers say they have enough capacity to meet expected demand. And a survey by the British Chambers of Commerce has found that only 36 per cent of services companies are working at full capacity.

A further problem is the same one that caused investment to be weak even in the years before the crisis - that there are few monetisable investment opportunities. As Robert Gordon of Northwestern University and George Mason University's Tyler Cowen have argued, the pace of technological progress has slowed, so there's just less for companies to profitably invest in.

Granted, this could change if driverless cars, graphene products, nanotechnology or 3D printers live up to their hype - although as your correspondent struggles with 2D printers he's sceptical - but even if they do, this is unlikely to be much help in 2013. On balance, the consensus forecast is for fixed investment to grow by only 2.2 per cent next year – less than its long-run average. Not uncoincidentally, therefore, economists also expect sub-par GDP growth, of just 1.1 per cent.

There are - of course - huge risks here. The Office for Budget Responsibility (OBR) said recently that "there is a roughly 20 per cent chance that the economy will shrink again in 2013, judging from past forecasting errors".

One reason for such risks - other than the obvious one that the future is inherently unknowable - is that capital spending is correlated across companies; if one invests more, others are likely to. This is partly because one company's spending is another's orders, but also because optimism is infectious. This raises the pleasant possibility that, if uncertainty does recede and capital spending rises, it might do so by quite a lot. Risks, remember, are on the upside as well as downside.

Consensus economic forecasts