Ben Chu: The long and the short of it is that we urgently need more investment


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The Independent Online

If you require evidence of the short-termism that bedevils our economy you probably require a new pair of spectacles. Bank bosses are still busily trying to pump up their institutions' returns on equity at the same time as they starve small and medium-sized companies (the growth drivers of the future) of loans for expansion. Pension fund managers have resisted the inducements of the Chancellor to invest in infrastructure bonds, preferring instead to carry on ploughing their money into risk-free gilts.

Big businesses, despite the slashing of corporation tax, relentlessly build up their cash piles and consider equity buybacks to support the all-important share price. Energy firms demand massive state subsidies to engage in new plant construction needed to keep the country's lights on.

The depressing results are plain to see in the national accounts. Business investment levels remain 13 per cent below where they were in 2007. This needs to change.

The Office for Budget Responsibility's forecasts for an eventual recovery are based on the assumption that business investment will pick up strongly from 2014. If that doesn't happen, kiss goodbye to the recovery.

This is, appropriately, the subject of Labour's first policy review, which reported this week. Written by Sir George Cox, a former head of the Institute of Directors, it argues that short-termism has become "an entrenched feature of the UK business environment".

This follows a similar report last year by the economist John Kay for Vince Cable's Business Department, which argued that executives are often focused on the next quarter's earnings rather than looking to the longer term.

Andrew Smithers, of the investment firm Smithers & Co, is also thinking along these lines. He argues that the stock-based bonuses awarded to UK company bosses in recent years have introduced a dangerous bias among managements towards pumping up profit margins at the expense of investment.

However, the solutions proposed by Mr Kay and Sir George have a different emphasis. Sir George calls for the capital gains tax regime to penalise people who flip their shares quickly and reward those who hang on for longer. He says late-coming shareholders should be barred from participating in takeover votes in order to disenfranchise opportunist hedge funds out to make a quick buck.

Mr Kay, on the other hand, who was commissioned by Mr Cable to look at whether there was a case for legislation to throw sand in the wheels of big corporate takeovers, is much less prescriptive. He suggests that new rules governing takeovers would probably do more harm than good, and anyway would only address the symptoms of the illness rather than the disease itself, which he identifies as the gulf between those who invest money and those to whom it belongs. Sir George wants new rules. Mr Kay wants broad cultural change. Of the two, Mr Kay is the more compelling.

But could these analyses be missing the point? Chris Dillow of the Investors Chronicle, and an insightful economics blogger, has a different take on the UK's investment dearth. He argues that it is, in fact, rational for firms to eschew long-term spending plans because the future is so uncertain. Why should a hi-tech firm, for instance, make spending plans for a decade hence when the inexorable forces of technological transformation might well wipe it out long before then?

This inescapable uncertainty is why John Maynard Keynes talked of "animal spirits". The belief that any given investment will result in strong revenues cannot be based on evidence – we cannot see the future and so must rely on irrational, even primal, enthusiasm. This analysis lends support to the idea that the authorities today should concentrate on stimulating those animal spirits in the economy, rather than them getting sidetracked with an attempted overhaul of corporate and investor incentives.

It's a compelling debate. Yet it's not clear to me why both descriptions of the world can't be true. Incentives in our corporate remuneration system and equity markets might well be inhibiting long-term investment. But weak demand could be exacerbating the problem. This would suggest we need to try to improve corporate and investor incentives while also injecting a bit of irrational optimism into the economy. If your trousers are falling down, it's generally a good idea to go for the belt and braces.