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Martin Chick on Keynes and public investment

3rd July 2013

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.



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