That the UK economy is suffering from a chronic lack of investment is plain to see from a variety of sources - unsurprising given the slashing of public capital spending over the coalition's first spending review, and the private sector's financial surplus of several hundred billion pounds. A report by the National Institute of Economic and Social Research (NIESR) shows that measures to reverse the dearth of investment would benefit the economy in both the short and medium term - the extent to which it would (and importantly the extent to which it wouldn't), suggests that a short-term, deficit-financed boost to investment is a necessary but insufficient condition for economic revival. Apocalyptic warnings from George Osborne's Treasury suggest that a penny of extra borrowing would somehow lead to a catastrophic rise in interest rates, endangering an already-fragile recovery. It is hard to predict how bond traders would react to a boost to investment, but NIESR's figures show that such a Keynesian investment programme would encourage growth, diminish unemployment and after the obvious rise in government debt and deficit to pay for the investment, decrease both in the medium term - hardly the conditions for a sovereign debt crisis to erupt. Crucially, NIESR's model found that the positive effects of a deficit-financed stimulus of this magnitude would be enhanced at times of economic crisis, when ordinary economic rules are suspended - such as, oh I don't know, today. So far, so Keynesian. It's simple really - borrow a little today (around 1% of GDP for two years, or £30bn in total), invest it in infrastructure (which the model shows to be more effective than simply spending more on general government spending), and sit back as the sunny uplands of prosperity come into view. Not quite - it's a bit more complicated than that, to coin a phrase. To listen to the Ed Balls tendency in the Labour party, extra spending in itself will solve the myriad problems in the UK economy. Indeed the other Ed, Miliband, recently said he would borrow to stimulate the economy - but would do so by cutting VAT. NIESR's data doesn't directly look at how such a cut would boost our economic health, but from past experience the likely answer is "not very much." A vulgar Keynesian might suggest that borrowing to spend on anything will boost the economy, no matter what you spend on. Not true, as this research - not to mention common sense - shows. Further, the effects of the stimulus are transient and are not exactly dramatic in terms of size. The best-case scenario is for a two-year, £30bn investment boost to raise GDP in real terms by something like 0.5% per year for the next decade. Admittedly, after an unprecedented depression where output is still several percent below the pre-crash peak, such growth would be welcome. Another point is that there may be a more dramatic positive effect on nomial GDP - the volume of economic activity before inflation is taken into account, which many economists insist is, at a time of severe crisis, the measure we really need to pay attention to. Perhaps the FT's Chris Giles, or NIESR Director Jonathan Portes, or even one of Twitter's leading market monetarists @Britmouse could say whether an investment boost would have an even bigger effect on nominal growth - I suspect it might. Whether it would or not is largely academic for most people. What ordinary people care about is whether they are in work, and whether they are paid enough to live decent lives (something I express a little more wordily here). Here it gets tricky. Unemployment would reduce somewhat in the short run, but then return quickly to the current baseline. Furthermore, as recent labour market stats show, traditional measures of unemployment are a poor indicator of the health of the economy and people's ability to secure decent living standards. Underemployment (expressed as people wanting to work longer hours than they currently do) is a significant problem, and wages continue to lag far behind the cost of living, holding back the economy. Again perhaps minds more capable than mine might be able to model the effects of an investment boost on wages. None of this is to say we shouldn't invest in infrastructure, borrowing to do so if needed. Vince Cable made that clear in his outstanding New Statesman essay recently. What it does suggest is that absent a large-scale remodelling of banking, power in the workplace and industrial strategy (more on which in SLF's Plan C, might I add), deficit-financed investment won't be the magic bullet we'd hope for. As I said above, it's a necessary but insufficient condition for bringing about the sort of economy we want to see.
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