Dr. Martin Chick, Ph.D, M.A. is a professor of Economic History at the University of Edinburgh. His recent research in Edinburgh and Paris focuses on the philosophical underpinnings of economic use of such concepts as utilitarianism, ownership, normativity and choice. He is currently writing the Oxford Economic and Social History of Britain since 1951, including themes such as income and wealth inequality, the allocation of health and educational resources, externalities and free-riding behaviour, public expenditure and capital productivity.
Introduction by Philipp Requat, European Ideas Ambassador at the University of Edinburgh
The efforts of a sceptical economics student have recently seen one of the most referenced underpinnings of austere policy crumble. An assignment by Thomas Herndon revealed that Harvard Professor Kenneth Rogoff’s famous 90% of GDP watershed point, at which government debt supposedly suffocates growth, was the result of a simple excel-mishap. Without the threshold’s quantitative backing, a light of sharp scrutiny has again been cast on the surge of government spending-cuts, mandated throughout Europe by innumerable politicians quoting Rogoff. Nations like Greece have been plunged into mass unemployment, social despair and an even deeper recession in the name of an imaginary border. Herndon’s remarkable discovery thus underlines the need for critical reflection upon an anti-Keynesian consensus that has shunned expansionary policy over deficit reduction. Common misrepresentations of crudely-categorised Keynesian thought oblige us to revisit the views of Keynes himself and consider what his stance actually commands. Public investment is amongst those aspects which merit particular interest, as the United Kingdom’s government turns its attention to the same in search for stimulus.
Recent UK government announcements on plans for the stimulation of the economy have pushed promised capital investment projects to the fore. On the basis of plans outlined in the 2015-16 Spending Round statement of June 2013, net public investment could run at 1.5% p.a. of national income until 2017-2018. This can be compared with 7.3% net investment/GNP in 1967-68. That year marked a high-water mark in post-World War II fixed capital investment, after which public investment began a trend decline. Total gross public investment as a percentage of GDP fell almost continuously from the mid-1970s, from 8.9 % of GDP in 1975 to 1.7% in 2000. Net investment was almost zero in 2000. While the current emphasis on promised capital investment might be loosely presented as ‘Keynesian’ in approach, its low historic share of national income is noteworthy and not always consistent with what Keynes actually wrote about capital investment. Famously, the central chapter of The General Theory (1936) concerned ‘The Marginal Efficiency of Capital’ and Keynes had also made more practical proposals regarding capital investment in the 1933 collection of newspaper articles which together formed The Means To Prosperity.
In The General Theory Keynes wrote of “a somewhat comprehensive socialisation of investment” as providing “the only means of securing an approximation to full employment”, although by socialisation he did not mean nationalisation since “it is not the ownership of the instruments of production which it is important for the State to assume”. By socialisation, Keynes envisaged “the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an even greater responsibility for directly organising investment”. This emphasis on the importance of capital investment, which for Keynes sequentially preceded concerns with liquidity preference and the multiplier, was allied to a focus on the returns earned on capital. Such a concern with the rates of return on capital investment became of increasing concern to the Treasury during the so-called Keynesian period of economic management between 1945 and 1975. The initial decision of the Attlee governments (1945-51) to nationalise mainly utility industries in monopoly form initially led to a simple requirement that such industries break-even taking one year with another. As public expenditure difficulties increased a move was made in 1961 to required these industries to earn an opportunity-cost based rate of return on their existing stock, and then from 1967 to subject proposed investments to a test discount rate. This move between 1961 and 1967 represented a shift from an ex post backward-looking view of how to extract higher returns from the existing capital stock to an ex ante comparison of the putative returns of competing potential capital investment projects. While discount rates were subject to political manipulation the Treasury concern with current and future returns on capital investment persisted. While the privatisation programme and the ‘Right To Buy’ council house sales of the Thatcher government are predominantly associated with a transfer of ownership, the origins of both programmes lay in efforts to improve the rates of return on capital investment.
By 1975, to have earned even a 3% return on council housing stock would have required rents to have been increased by 50%. As the political difficulties of doing this to lower-income tenants became apparent in a housing sector characterised by tax relief on mortgages and the absence (since its abolition in 1963) of any tax on the imputed income from home ownership, so thoughts turned to changing the existing policy of allowing councils to sell off surplus stock to one of giving tenants a right to buy. Councils had long had the ability to sell off council house stock, but the ‘Right To Buy’ programmes of the Thatcher governments shifted the emphasis from public sale to private purchase. Largely as a result, council house sales averaged 130,000 p.a. between 1980 and 1990, compared with 3,000-5,000 p.a. in 1960-1967 and 8,000 in 1968-1970. Whereas in the mid-1970s, slightly more than half of all dwellings were occupied by their owners, by the mid-1990s, the proportion had increased to more than two-thirds. In capital investment terms, the effect was significant. While investment in housing remained at 20% of total investment, the contributions of public and private investment were reversed. In 1950, 3.4% of investment in dwellings was private and 16.3% public; in 1994 of the 20.9% total investment forming in housing, 18.2% was private and 2.7% public. On some estimates the combined effects of the privatisation of council houses and nationalised industries was to reduce the public sector net worth from 41.7% of GDP in 1970-71 to 15.6% in 1999-2000. However, there was no ostensible reason why investment formation in former – now privatised industries should fall; indeed, free of public spending constraints and with access to international capital markets it might have been expected to increase. That public investment did fall was partly a function of the reduction of public investment in the no-longer public utilities and housing, but also reflective of the increased share within public expenditure of health and social security spending which contributed to public expenditure pressures such as to squeeze out capital investment. Current spending rose in relation to investment spending. Between 1958-59 and 2007-08, the ratio of current to investment spending increased from 10:1 to 19:1 in 2007–08, hitting peaks of 118:1 in 1988–89 and 70:1 in 2000–01.
In his 1933 The Means to Prosperity, Keynes argued that as a first step to recovery that bank credit should be made cheap and abundant, and that, secondly, that the long-term rate of interest should be low for all reasonably sound borrowers. However, he then went on to argue that “even when we have reached the second stage, it is very unlikely that private enterprise will, on its own initiative, undertake new loan-expenditure on a sufficient scale”. The reluctance of business to expand until after profits begin to recover, and the fact that increased working capital would not be required until after output began increasing, meant in Keynes’s view that an important role fell to those public and semi-public bodies who undertook “a very large proportion of our normal programmes of loan-expenditure”. In contrast to the “comparatively small” new loan-expenditure required in a year by trade and industry, Keynes emphasised how “building, transport and public utilities are responsible at all times for a very large proportion of current loan expenditure”. Therefore in leading off an attempted recovery, “the first step has to be taken on the initiative of public authority; and it probably has to be on a large scale and organised with determination, if it is to be sufficient to break the vicious circle and to stem the progressive deterioration, as firm after firm throws up the sponge and ceases to produce at a loss in the seemingly vain hope that perseverance will be rewarded”.
Building, transport and public utilities all feature prominently in current UK government promises of future capital investment. All also give cause for concern if attention is paid to their opportunity costs rates of return on capital. The current approach to housing is more likely to increase the price of the existing stock rather than bring forth significant new construction and this at a time of housing shortages and proportionately high rents to lower-income groups in areas such as London. Were the government to finance the construction of new low-rental housing it could still earn a social rate of return on capital which would exceed its own costs of borrowing, thereby trading off a reduction in its operating deficit against an increase in long-run debt.
In utilities, notably electricity, protracted negotiations over the construction of new generating capacity continue and effectively centre on the question of whether or not the government should provide a guaranteed rate of return on new fixed capital investment. The risks arise from uncertainty as to the future relative price of competing sources of electricity since, while nuclear is always likely to provide a large share of the base load, the price it will receive depends on the level of prices as influenced by other suppliers. The State could reduce the risk and apprehension by effectively offering some form of guaranteed return on asset base, something which it appears willing to do for other energy projects, such as wind power, through the use of the Renewable Obligation. Yet, the economics of wind power are very questionable, being expensive to maintain and to connect to the electricity grid, and still requiring generating capacity to be built sufficient to provide power at peak time when the wind may not be blowing. When the wind is blowing, and suppliers are obliged to take wind-produced electricity, it simply reduces the load factor of the existing, necessary, non-wind generating capacity. In photovoltaic cell technology, where the rate of technological productivity improvement is potentially so rapid as to diminish its commercial attractiveness to potential buyers (they could buy something much better and quite possibly much cheaper in two years time), then there is a strong case for government support and subsidy.
Finally in transport, the HS2 project is likely to cost more and take longer to construct than is currently estimated. Quite why the foregoing of current consumption or an alternative use of capital investment resources by the current generation so as to enable a future generation to travel faster is thought to be the best use of resources is puzzling. Building fixed transport links between two points, be it the Channel Tunnel or the HS2 link, seems an inherently risky investment when set against the flexibility offered by motor vehicles and airplanes. Why railways receive proportionately so much more resources than roads is also bemusing. About 12% of household expenditure goes on cars, rail is increasingly used by medium and higher-income groups and railways convey only about 7% of the national passenger miles (mainly in London and the South-east) and a similar proportion of freight tonne-miles. Most of the rest is on roads. Spending on preventing fatalities on railways is one hundred times higher than that on roads.
In a longer-term historical perspective, current UK government plans for net capital investment seem small-scale and paradoxically containing high-risk constituent projects whose rates of return on capital are likely to be low. Where government might offer more ‘socialised’ Keynesian rates of return, as in energy, so as to bring forth more investment, it seems reluctant to do so, although it is prepared to restrict current consumption in order to allow time-savings on rail travel in the future. Much of this might have appeared odd to Keynes. Not that capital investment in housing, transport and utilities is not to be encouraged, but rather that in selecting projects more attention might be paid to their rates of return on capital and the vaunting of their long-term benefits dampened by the reminder that in the long-run we are all dead. More, small, dispersed, publicly-financed capital investment projects with quicker, short-term returns might be more to the immediate point.