It would be tempting to say that this demonstrates the long-term failing of banks. They have for decades been keener to inflate the property market than to undertake the tricky task of assessing business projects. Whilst this is partly true – economists at the NIESR have found “evidence of constrained credit supply” to small businesses – it is not the whole story. The Bank of England says “demand for credit from small businesses decreased significantly.” Two facts corroborate this:
- Very few manufacturing firms – a sector not famed for celebrating the generosity of banks – report credit constraints. A survey by the CBI is January found only four per cent reporting that a lack of finance was constraining output, and only five per cent said it was limiting their investment plans.
- Firms were loath to invest even before the crisis, when credit was (overly) abundant. The share of business investment in GDP (in nominal terms) fell during the 00s, and companies’ retained profits exceeded their capital spending after 2002. This is consistent with a long-term dearth of profitable investment opportunities.
And with demand weak and still considerable uncertainty about the euro zone, it’s easy to see why firms should still be loath to invest and borrow.
Keynesians would argue that this represents an argument for using expansionary fiscal rather than just monetary policy. If firms are unwilling to invest then a policy of cheap money and plenty of it – insofar as it works – is likely to inflate the housing market more than increase the economy’s supply potential. By contrast, a fiscal expansion might stimulate private investment through an accelerator effect and because a rise in aggregate demand would raise profit expectations.
This, though, is unlikely to happen. Instead, our best hope for a pick-up in credit demand and in corporate investment lies simply in the passage of time. I mean this in two ways:
- Long periods of weak investment naturally come to an end simply because replacement demand increases. Machinery gets worn out and needs replacing, and software and servers need updating. This is one reason why the early phases of an upturn tend to be “feel bad recoveries”: companies raise their spending even though their spirits are depressed. Indeed, the volume of business investment has edged up since 2010.
- Sentiment mean-reverts; just as euphoria never lasts forever, neither does depression. Eventually, then, an improvement in animal spirits should cause companies to invest more. It would be premature to claim that the rise in mid-caps’ stocks is a sign that animal spirits have turned. A better indicator would be for Aim stocks to rise relative to the broader market.
It is possible, then, that we could soon see a slow pick-up in corporate investment, which could accelerate later as sentiment improves. But this might happen despite economic policy, rather than because of it.
