Common sense should prevail to promote investment

'Should we be satisfied with the UK's performance? The Deputy Governor of the Bank of England, suggests not. He points out that the share of investment in GDP in the UK is much less than in other comparable economies - a matter of considerable concern'

It is sad in many ways that the role of investment in promoting a high standard of living and faster economic growth has become a political football in the UK, since many common sense propositions which most sensible people would instinctively believe are now the subjects of acrimony and distortion.

The common sense propositions that I have in mind are that more capital investment is better than less; that the quality of investment is as important as the quantity; that it is crucial to invest in people as well as in machines; that technical progress is easier to introduce when investment is high; and that public policy should feel a responsibility to address all of these areas. If you already share these common sense propositions - if you are, for example, Gordon Brown - please stop here, lest the remainder of this column should shake your sensible beliefs. For the rest, please read on.

Should we be satisfied with the UK's investment performance? A recent speech by Howard Davies, Deputy Governor of the Bank of England, suggests not. He points out that the growth in investment since the trough of the last recession has been much less than that following the two previous downturns, and that the share of investment in GDP in the UK is much less than in other comparable economies. He believes this to be a matter of considerable concern, though he points to some mitigating facts. While investment has risen less than usual in the present recovery, it also fell by less in the last recession, so it is natural to expect a smaller bounceback. Investment in plant and machinery has been less disappointing than that in construction, which may be less important for boosting growth. Furthermore, in reality the level of equipment investment may have been greater than shown in the official data, reflecting a much greater fall in computer prices than the official statisticians have allowed.

The government takes these extentuating arguments one stage further, claiming that new forms of investment have become much more productive than in earlier periods, and that the sluggish rise in capital spending in the past couple of years is therefore no cause for concern. There may be some truth in this, since there is plenty of anecdotal evidence that firms are now able greatly to enhance the productive potential of old machinery by ''tweaking'' it with a new piece of computer technology. But this argument should not be taken too far. Business surveys show that firms felt constrained by a shortage of capacity in 1994, after only a modest bounceback in manufacturing output, and recent surveys suggest that even in the service industries capacity utilisation is reported to be high. This indicates that the UK is still plagued by its old problem of capacity shortage during an upswing.

Still more important is the question of whether UK investment is too low on average over the cycle, and whether this is responsible for depressing our long-term trend rate of economic growth. This proposition, which is at the heart of Labour's economic analysis (and which is not particularly denied by the Tories), has been the subject of recent attack, including from Bill Martin of UBS, who seems to think that extra investment is unimportant. His argument, which reflects a raging debate in the academic community, rests on two strands.

First, he says that higher investment over the long term will not lead to higher growth. Why? Because of diminishing returns to scale. Every extra unit of equipment that is added to the capital stock produces a smaller return in extra output than the previous unit, so any benefit to growth is temporary.

Even if this is true, I would argue it is irrelevant, because a temporary boost to the growth rate of capital and output leaves the absolute quantity of each at permanently higher levels, even after the growth rate has returned to its original state. The US and the UK may now be growing at similar trend rates, but because the level of the capital stock and output is higher in the US, America remains permanently better off than Britain. If extra investment can temporarily boost the growth rate of output, while permanently boosting the level of output, that is a goal well worth pursuing - end of story.

What is more, there are severe doubts whether the law of diminishing returns actually applies in the real world. New growth theorists such as Paul Romer, Brad de Long and Larry Summers (all American, unfortunately) claim that returns to investment can often be increasing rather than diminishing, especially if investment takes the form of new plant and equipment in manufacturing, or of extra education and training for the work force. If true, then these forms of investment should permanently boost the growth of output, as well as its level.

If extra investment is a good thing, what can we do about it? Some obvious steps seem to be worth trying - for example, cutting the budget deficit to reduce interest rates; emphasising low inflation and macro-economic stability; tilting public spending away from social security and towards infrastructure spending and education; restoring incentives for R&D and training; and encouraging companies to retain rather than to distribute profits. Even if these measures were to boost productivity growth by only a fraction of a decimal point each year, they would pay handsome dividends over a decade or two.

Start your day with The Independent, sign up for daily news emails
Life and Style
love + sex
Life and Style
Tikka Masala has been overtaken by Jalfrezi as the nation's most popular curry
food + drink
A propaganda video shows Isis forces near Tikrit
voicesAdam Walker: The Koran has violent passages, but it also has others that explicitly tells us how to interpret them
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Graduate Application Support Analyst

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Reach Volunteering: External Finance Trustee Needed!

Voluntary post, reasonable expenses reimbursed: Reach Volunteering: Would you ...

Christine McCleave: FP&A Analyst

£36,000 - £40,000: Christine McCleave: Are you looking for a new opportunity a...

Recruitment Genius: Sales Executive - OTE £40,000

£15000 - £18000 per annum: Recruitment Genius: This is a great opportunity for...

Day In a Page

Syrian conflict is the world's first 'climate change war', say scientists, but it won't be the last one

Climate change key in Syrian conflict

And it will trigger more war in future
How I outwitted the Gestapo

How I outwitted the Gestapo

My life as a Jew in wartime Berlin
The nation's favourite animal revealed

The nation's favourite animal revealed

Women like cuddly creatures whilst men like creepy-crawlies
Is this the way to get young people to vote?

Getting young people to vote

From #VOTESELFISH to Bite the Ballot
Poldark star Heida Reed: 'I don't think a single bodice gets ripped'

Poldark star Heida Reed

'I don't think a single bodice gets ripped'
The difference between America and Israel? There isn’t one

The difference between America and Israel? There isn’t one

Netanyahu knows he can get away with anything in America, says Robert Fisk
Families clubbing together to build their own affordable accommodation

Do It Yourself approach to securing a new house

Community land trusts marking a new trend for taking the initiative away from developers
Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

Money, corruption and drugs

The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

150 years after it was outlawed...

... America's first slavery museum is established in Louisiana
Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
Tony Oursler on exploring our uneasy relationship with technology with his new show

You won't believe your eyes

Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

Moores must go. He should never have been brought back to fail again

The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn