Letter: Growth and investment

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Sir: In his reprise of the investment-economic growth theme, Gavyn Davies ("Capital reasons for extra public investment", 17 June) makes two errors, one of attribution and one of inference.

His first mistake is to attribute to me views which I do not hold, namely that "investment is irrelevant for growth, or otherwise unimportant for government policy". In fact, it is wholly uncontroversial that a spontaneous rise in the ratio of physical investment to the gross domestic product would increase the UK's medium-term growth rate. What is at issue is the scale of that growth uplift and whether it persists into the longer term.

At the risk of diminishing returns, I will briefly restate my judgement. I believe traditional economic theory is correct in saying that the impact of extra physical investment on growth depends on the (modest) rate of return on capital and is ultimately transitory. By contrast, Mr Davies, writing under the influence of new growth theorists and the empirical work of De Long and Summers, reckons that the effect could be large and persistent.

This is his second mistake. Like those authors, Mr Davies would infer from the growth experience of emerging economies in Asia and Latin America that there are large growth gains to be had from extra physical investment.

This may be true for economies at that stage of development, but it is incorrect to suppose that the same would apply in the UK. There is quite enough variation in growth and investment experience in the developed world adequately to test the De Long-Summers proposition that plant and machinery investment would yield large growth benefits in mature economies. Those tests, together with more detailed research of UK manufacturing industry, pretty decisively reject their new view in favour of the traditional proposition to which I therefore subscribe.

In his concluding remarks, Mr Davies realises that the policy implications are not as straightforward as "more capital investment is better than less" - one of the "common sense propositions" which he advanced in his first article. In the past, governments which have set out with an agenda to raise capital spending have often ended up subsidising inefficiency and creating other market distortions along the way.

I suggest that a preferable agenda, informed by recent growth experience in the UK, would be to set policies which encourage technological transfer, higher efficiency and better resource allocation.

I appreciate that the headline is less catchy than one that sings the praises of physical investment, but in this matter it is right not to pander to the priors of those who are unwitting victims of a 1960s mindset.

BILL MARTIN

Chief Economist

UBS Ltd

London EC2

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