Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 12 July 2012

Private investment, public investment and the private finance of public investment

                When the UK government announced its austerity programme in 2010, it believed that private investment would help fill the gap in demand created by cutting public spending, and in particular offset its very large cuts in public investment. That did not happen, and according to OECD forecasts, is not going to happen in a significant way anytime soon.

UK Investment Growth (Source, OECD Economic Outlook June 2012)

                The obvious response is for the government to borrow to increase public investment, particularly when it is so cheap to do so. But that is a no-no as far as the Chancellor is concerned. So around the time of the budget it announced its solution to this dilemma. It would provide government guarantees to private investment projects, but it would also encourage the private sector to fund traditional public sector investment, like roads.
                Jonathan Portes is right that this is a victory of sorts. In particular, it suggests the government believes monetary policy will neither be sufficient to bring about a recovery on its own, nor will monetary policy counteract any attempts through fiscal policy to increase demand. In addition, as lack of demand is the critical problem right now, anything that might help should be welcomed.
                However, it has to be said that private finance for public investment appears illogical, as Alasdair Smith argues at the FT today. (See also Martin Wolf earlier.) The only clear ‘advantage’ of this approach is that there will be no immediate impact on the measured public sector deficit. But this policy will increase deficits in the longer term. The bottom line is that taxes will have to rise to pay for this investment, and merely shifting when the deficit increases from the present to the future does not alter this reality.
                Unfortunately we have been here before, with the Private Finance Initiative (PFI) used extensively by the previous Labour government. The consequences of PFI are set out in the Office for Budget Responsibility’s (OBR) annual look at the long term position of the UK public finances published today. It does this in two ways. The first, and most straightforward, is to project those finances over 50 years, a time period over which accounting tricks largely wash out. The second is to calculate ‘Whole Government Accounts’, which attempt to add a measure of future government liabilities to the published debt numbers. The OBR notes that “If all investment undertaken through PFI had been undertaken through conventional debt finance, PSND [public sector net debt] would be around 2.1 per cent of GDP higher than currently measured.”
                But it is worse than an attempt to fool the public (and presumably the markets) through bad accounting. The policy is also almost certain to end up costing more. Alasdair Smith suggests that this could involve borrowing at nominal interest rates of 5-7%, compared to interest rates on government debt of around 3%. To quote: “Looking at it another way, the stream of interest and capital repayments that would enable £20m to be raised from private finance would fund between £27m and £34m of public borrowing”.
                Professor Smith ends his article with “The OBR should use the platform of its fiscal sustainability report to give strong advice on how best to finance infrastructure investment.” Unfortunately for the time being at least he will be disappointed. As I have noted before, when the OBR was set up the government was very careful to ensure that its mandate involved crunching numbers but not looking at alternative policies, let alone giving policy advice. From the point of view of good public policy, that was a serious mistake, precisely because it makes it easier for the government to get away with accounting tricks that end up costing the public a lot of money. 


  1. Simon, in the second last paragraph you compare the borrowing costs of the public and private sector and note that at current rates the public sector can borrow at a significantly lower rate than the private sector.

    Does this represent a real efficiency gain (does the public sector have a comparative advantage in financing investments?) or is the public sector providing an implicit guarantee that lowers the cost of the loan, and therefore should be considered as part of the borrowing costs?

  2. I think the way the public investment debate is being framed is unhelpful.

    It is deeply misleading for macroeconomists to imply there is some "holding everything else equal" view on aggregate demand, that govt cuts to public investment will necessarily reduce demand *because you can hold everything else constant*; or that increases will boost demand on the same logic.

    Recent UK history does not exactly support that view, either. The massive boost to public sector investment spending in 2008-9 was co-incident with the largest fall in nominal demand on record. The subsequent withdrawal of that spending in 2011 was co-incident with slowing, but still positive, growth in nominal demand.

    Indeed, the falling contribution to whole economy gross fixed capital formation from the public sector has exactly been offset by growth in private sector spending; with total GFCF being roughly flat over the last few years. It is certainly correct to say that Osborne (and Darling) expected an even larger boost to private investment.

    It is also worth noting that Osborne is following Darling's plans for (on-balance-sheet) public sector investment almost to the letter; withdrawal of investment spending was always going to form the major part of the fiscal consolidation, in part because Darling specifically brought forward a bunch of capital spending from 2011+ to 2009/10 as a stimulus measure.

  3. "The massive boost to public sector investment spending in 2008-9 was co-incident with the largest fall in nominal demand on record."

    Can you provide me with a link to this data?


  4. Pension leads can be a very difficult process,especially if beginning without a definite plan of action.The results of Granger causality test show that higher saving and investment lead to better economic growth.
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  5. Simon, in the second last paragraph you compare the borrowing costs of the public and private sector and note that at current rates the public sector can borrow at a significantly lower rate than the private sector. Ascenergy

  6. Anything and everything that the State owns and controls is rationed:
    fibre-to-the-home broadband
    etc etc

    This is a systemic problem, dating back (at least) to the squandering of Marshall Aid on the Welfare State, rather than rebuilding national infrastructure after WW2.

    The solution, surely, is to remove all such areas from State control and to allow the private sector to own, run and expand them, being paid by HMG by results: in short, rather than imposing ever-more regulations on businesses, HMG should be going to companies and asking what they, HMG, can do to promote their expansion.

    That means (for example) repealing the scientifically-illiterate CCA (the UK produces just 1.2% of the 8% of annual CO2 which is Man-made); removing all market-distorting energy taxes and subsidies and actively promoting the cheapest possible energy sources, since cheap energy = better lives for us all.

    The 'warmists' (who seem to be driving almost every aspect of HMG policy over the last decade or so) seem to imagine that Mankind's technological progress will end today.
    It's 1915 - did anyone envisage the iPhone6S?


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