4 Apr 2013

Spending vs Investing - updated

There seems to be some confusion amongst people who comment on news articles online and politicians about the distinction between spending and investing. Thus when the people say things like "So in a nutshell, what will you do? Spend or not spend?" it completely overlooks the other possibility.

We spend money when we get what we pay for and nothing much else. However the govt is in the enviable position of getting multipliers. As it spends money on welfare, those receiving the payments spend almost all their welfare in the real economy - on rent, food and basic services. This helps to keep money flowing through the economy - like cash flow in a business. And since tax is paid on what is earned and spent a lot of what they spend comes right back to government, to go through the system again.

Investing is a totally different proposition. If I invest in building a house I pay the money up front but then I sell the house at a profit once it's built. Building houses in the UK is very profitable because houses sell for about 5x what they cost to build. You spend £50,000 and sell the house for £250,000. This is the essence of capitalism - investing capital in order to make a profit. And that £50,000 is also spent - so a lot of it goes through the same cycle as other spending and comes back to the govt as taxes.

The IMF have confirmed that the major contribution to government borrowing at present is reduced revenue due to the depression. Demand for goods and services has dropped off dramatically so that the economy is now hovering around zero growth (with a few ups and downs). Thus tax revenues have fallen off and the government has spending commitments which it must meet by borrowing.

The present government has a strong ideological commitment to allowing the real economy ('the market') to take care of themselves and to reduce spending by making cuts. They have made minimal attempts to encourage lending for investment but these seem to have been in ignorance of the massive debts held by the private sector (despite this information coming from government Budget Reports - esp 2011 and 2013).

The other option, the one that the Chancellor had built his hopes on was that part of the private sector is sitting on a large surplus. This surplus capital is of a scale that if it was invested it would stimulate the UK economy. However while demand is low investors are rationally and understandably reluctant to risk their capital, and more or less unable to borrow to invest as banks see the same economic conditions as making loans risky (this is aside from the fact that the banks created this problem by lending too much money in the first place).

In addition the government's austerity policies (again according to the IMF) are depressing demand in the short term. While demand is low the private sector cannot (because of too much debt) or will not (because of too much risk) invest in the UK economy and we stagnate. And this will simply go on until the levels of debt fall low enough to make an impact on demand. No one knows how long this will take. The March figures from the ONS show that household and private sector deleveraging is more or less stagnant - we stopped paying off debts in 2012. So the process could take a very long time indeed.

And what is more, while the private sector is running a surplus (hoarding money) the government must run a deficit (i.e. must borrow more than it earns, ratcheting up the national debt). What we need is the converse - the private sector running a deficit - borrowing to invest and making profit - and the government to run a surplus (paying down debt with the extra as well as investing in infrastructure).

The govt is the one with the power to take a different path - to move more decisively from spending to investing. It can borrow at much lower rates than the private sector over longer terms and has a huge asset base so the risk is very low. There is risk of course, but the is greater risk from the current strategy of austerity and inaction.

The failure on the part of the public to distinguish between spending and investing has been exploited by the government to pursue their ideologically driven policies. They won't borrow and spend as they say, but in this they include borrowing for investment as though spending and investment were exactly the same. Their investment program is far too small to make any difference. Plans to invest more always involve spending less in other areas. The extra investment is too small, and the impact on demand of less spending is far more significant. With investment lumped in with spending the government is able to maintain minimal support for their policies - though cracks are beginning to show.

Beyond the present government it's not clear whether Labour, the current opposition, are any more able to make the distinction and exploit it than the Tories and their LibDem sidekicks are. labour have said they would cut less, but not whether they would invest more.

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Keep is seemly & on-topic. Thanks.