Monday, 24 August 2015

Making the case for public investment

Jeremy Corbyn’s “People’s QE” scheme has been extensively discussed in the media. In fact it has caused something of a storm. The FT’s Chris Giles did an excellent balanced analysis of it, and there have also been useful contributions from – among others - Oxford University’s Simon Wren-Lewis, The Economist’s Buttonwood and FT Alphaville’s Matt Klein. The extent of discussion is far more, in my view, than the scheme deserves.

The scheme envisages that the Government, via a public investment bank, would issue bonds for infrastructure development, which would then by bought by the Bank of England as part of a QE programme. The architect of the scheme, Richard Murphy, suggests that to avoid accusations of monetary financing of government – which is a breach of the UK’s obligations under the Lisbon Treaty – the bonds would be issued to the private sector initially at a price set by the Bank of England, which would then hoover them up in (presumably compulsory) secondary purchases. I find it hard to see how this complies with the spirit of Article 123, but I’ll let that pass. My real objection 
to this scheme lies elsewhere.

The need that this scheme ostensibly addresses is the desperate need for investment in infrastructure, R&D, skills and social housing. Few, I think, would disagree with this. Private and public sector investment in Britain have both been well below levels in most other developed countries for a long time. The Coalition government not only reversed the modest investment spending increases of the previous Labour government, it made deep cuts: halving the deficit between 2010 and 2015 was achieved in part by halving investment spending. Despite interest rates at unprecedentedly low levels, government investment in the future of the economy is now at its lowest for over a decade (ONS, 2014):

Not only is investment desperately needed, safe assets are too. Savers suffer from cripplingly low returns on their savings in part because the supply of government debt – which makes up a substantial part of pension investments - has been restricted by QE, raising its price and hence depressing its yield. The Bank of England currently owns about 30% of the UK’s stock of gilts. Of course, the loss in yield is offset by the gain in price. But for those who live on the returns on their pensions, this is cold comfort. The last few years have been grim, and there is no end in sight: interest rates remain on the floor and the Bank of England shows no signs of unwinding its QE purchases. The Coalition government offered some relief to pensioners with its Pensioner Bonds, which enabled retirees with liquid savings to buy government bonds at above market rates. But this is a drop in the ocean.

The fact is that there is plenty of demand among UK residents for UK government debt, including longer maturities, and plenty of potential public sector investment projects that could be funded by long-term government debt. Government debt is the safest form of saving available to UK residents, as well as an important anchor in the financial system. There is absolutely no reason from an investment point of view to restrict its supply.

But a toxic narrative has grown up around government debt. Because of events in the Eurozone and some unhelpful academic research, we have learned to regard it as something bad to be eliminated – a burden on future generations, a drag on growth, a source of fiscal vulnerability. At very high interest rates, this would be true. But at today’s very low interest rates, the return on the vast majority of investments would far exceed the cost, even if bonds were issued at a premium to market rates as the Pensioner Bonds were. Tomorrow’s pensioners would be supported by the returns on their investment today, while their children and grandchildren benefited from modern infrastructure, better education and a higher standard of housing. And importantly, businesses of the future would benefit from investment in R&D and innovation. We need to stop regarding government debt as something malign, and start regarding it as a social good. It is the investment of today’s citizens in their own future and the future of those they love.

How the Government should organise the financing of public sector investment projects is a matter of some debate. Richard Murphy envisages a public investment bank, capitalised by the government, which would issue bonds to fund itself and lend funds to suitable projects. But the government is already its own bank: it could simply issue bonds directly to the public to fund specific projects. The UK has historically funded wars by issuing War Bonds directly to the public. Why should it not finance infrastructure projects, R&D, education and social housing construction by issuing Development Bonds?

An alternative would be a leveraged Sovereign Wealth Fund, which would fund itself by issuing bonds which it would use to purchase assets. This could include taking equity stakes in housing, infrastructure developments and - possibly – innovative start-ups.  Clearly such a fund would take risks, but importantly these risks would not be passed on to the people whose life savings would be funding it. Government can eat losses much better than small savers. Anyway, there is no particular reason why a leveraged sovereign wealth fund should lose money overall if it is properly managed, even with a scatter of project failures.  

The arguments of those who object to public sector investment on the grounds of inefficiency usually rest on the belief that government does not evaluate projects properly or manage them effectively. They ask how “malinvestment” would be prevented. There are, of course, examples of project failure in the public sector, some of which have caused major losses. But this is to ignore the many projects that do deliver on time, to budget and deliver the required returns, particularly in local authorities. 

Professional project evaluation and management is as necessary in the public sector as it is in the private sector. Potential projects should be subject to rigorous cost/benefit evaluation with sensible hurdle rates of return. Of course it can be difficult to establish tangible benefits for social projects, but not even to attempt to do so is lazy. Government projects should aim to deliver real returns just as private sector ones do. And they should be properly managed. The mistakes that led to the cancellation of the NHS project - and other expensive failures - were elementary project management errors. These are as common in the private sector as the public sector: but private sector project failures are swept under the carpet, whereas public sector ones make headline news. The possibility of failure should not deter investment in the public sector any more than it does in the private sector.  

Of course, borrowing for investment does have limits. When governments are very highly indebted, investors start to get worried and bond yields start to spike. But we are nowhere near that limit. Japan currently has debt of over 200% of GDP. For much of the last century, the UK’s public debt was well in excess of 100% of national income, as indeed it was for much of the previous century too (Ritschl, 1996):

Neither Japan nor the UK has ever defaulted on public debt. Indeed, Japanese government bonds and UK gilts are regarded as among the safest investments in the world. Even quite a sizeable increase in public debt for investment purposes would be unlikely to change this, especially if investors knew the Bank of England stood ready to buy bonds if necessary to stabilise yields. Having a trusted and effective central bank guarding your back makes a huge difference to sovereign creditworthiness. It is this that the Eurozone lacks, and it is for this reason that comparisons with say Greece are invidious.

But there is an additional problem. The UK is still running a fiscal deficit of 5.5% of GDP. How can a substantial investment programme be undertaken without vastly increasing this deficit?

I don’t wish to dismiss the deficit as unimportant. But it is not relevant to the discussion of investment spending. The present situation is that what we might call the “day-to-day” spending of the government exceeds its revenues. I am personally of the opinion that trying to reduce this directly has untoward effects and it would be better to focus on measures to improve productivity and wages, but I recognise that to many people a persistent deficit spells disaster. But judicious investment spending can be expected to raise national income and therefore both increase government revenue and reduce its spending. For example, investment that results in higher productivity feeding through into higher wages means more tax revenue for government AND lower welfare bills. Investment spending has long-term benefits on both sides of the public balance sheet. Indeed, that is its purpose! 

Failing to invest in projects which have clear positive returns on the grounds that it would increase the current deficit is a false economy. So investment spending should not be counted as part of the “current” deficit at all. This is the strongest argument in favour of a public investment bank or sovereign wealth fund rather than direct public investment. It makes the distinction between current and investment spending crystal clear and forces the real returns from investment spending and asset acquisition to be recognised in public accounts.

The UK needs investment spending. Restricting investment spending while interest rates are so low is not “responsible management” of the economy. Unfortunately, none of the candidates for Labour leadership have so far pointed this out. All of them – including Mr. Corbyn – have tacitly accepted that eliminating the deficit is top priority and government debt serves no useful purpose. I find this depressing. And I find it even more depressing that Mr. Corbyn, who at least acknowledges the need for investment spending, fails to address this poisonous narrative head on, preferring to propose a form of financial engineering that would deny Britain’s savers the opportunity to invest in their future for better returns than they currently get. In this respect, “People’s QE” it is not.

It would of course be perfectly acceptable for the Bank of England to buy “Development Bonds” as part of a QE programme in a future recession. Richard Murphy believes that in 2020 there will be a recession. If he is right, then a Jeremy Corbyn-led government could indeed do “People’s QE” as he outlines it. But I fail to see why investing in the future of the economy should be dependent on there being a recession. And I fail to see why it has to wait for 2020, either. Her Majesty’s Opposition should get its act together and make the case for investment NOW. 

A shorter version of this post was published in the FT on 24th August 2015.

Related reading:

Image from The Independent.


  1. I agree with the need for investment now in the UK and America. Murphy and Corbyn are presenting a challenge and alternative to a bankers QE should we hit a recession again, and we will - probably while at the Zero Lower Bound with fiscal policy being blocked by deficit hawks.

    If they can get a National Investment Bank up and running and funded via QE, perhaps they can it keep it going with regular government spending and accounting once the economy has *fully* recovered. But here in the U.S. the economy hasn't fully recovered from the last downturn all of these years later.

    1. You seem to have completely missed the point of the post. There is absolutely no need to fund a National Investment Bank with QE. Indeed waiting until QE was justified on economic grounds would cause a completely unnecessary delay to much-needed public investment. There is more than adequate demand for public debt and therefore no need to risk the wrath of the European Commission by monetising new issuance, whether for infrastructure development or anything else. They can and should get a public investment bank up and running perfectly well without any diirect involvement from the Bank of England: all that is needed is for the Bank to do its usual job of setting a floor under the price of government debt.

    2. Perhaps, though, they will fund investment through borrowing and use PQE in a recession to offset borrowing and, where possible, bring forward investment spending.

      That was my take on what they're planning anyway.

  2. I get the feeling that the terminology is just playing to the "credibility" crowd. Government expenditure is "unacceptable", but apparently QE is, so why not dress up government expenditure as "People's QE".

    It generates a lot of rather pointless hot air and disputation - without addressing the fundamental issue that the deficit is not a problem per se.

  3. I agree with your observation that Corbyn could do more to challenge the narrative of debt reduction. He has done something useful though in offering a challenge to the idea of central bank independence. See here why this idea is not as sacrosanct as we think

  4. The question as to how best to fund public investments like infrastructure is extremely complicated, and I certainly haven’t got all the answers. However, the Corbyn / Murphy proposal is nonsense and for the following reason.

    “Print and spend” is a form of stimulus. If P&S money is concentrated on infrastructure, then I years when little stimulus is needed, infrastructure projects will shrink dramatically, or grind to a complete halt. Barmy.

    I.e. infrastructure should be funded from the usual sources: tax and/or borrowing. As to P&S, that’s a perfectly viable form of stimulus (Keynes and Milton Friedman advocated it). But P&S money should be spread fairly widely over different government departments, plus there’s no particular reason to confine it to capital rather than current spending.

  5. I must admit I've never been able to understand the point of people's QE. Deficit spending *is* people's QE, surely? Framing it in such a way just means conceding ground to the defecit hawks, when really the entire fault deficit mania is what should be tackled in the first place. Furthermore, as proposed, wouldn't a people's QE potentially lead to potential instability, as banks would just end up with yet more excess central bank reserves sat on their books after the compulsory bond purchases?

    1. I think it's just floated as part of the shell game. The shill implies you'll get some thing. You agree to play and some one else gets some thing from you that you miss later.

      How many decades have they been taking dropping money onto people. I have not seen it. Maybe Ari knows how to get it. He seems to be all for money printing.

    2. Correction:
      talking about dropping currency

    3. As far as I'm concerned it's looking at the question completely wrong anyway. The question is not whether the UK has sufficient money to improve our infrastructure, because quite obviously we do because pounds are not something we're going to run out of. The question is whether we have the real resources (energy, manpower, cement, steel and so on) available to us to build out the infrastructure that we desire and if we want to allocate them to that purpose, and frankly I'm not convinced that we can answer yes to either of those. The north sea is dying, our coal mines are depleted, and we've not undertaken many giant infrastructure projects in a long time (good luck finding sufficient engineers for a large scale nuclear buildout, for example).

  6. What are the public projects that have "clear investment returns"?

    There's a paradox here: any infrastructure project that produces a clear future cash flow that's larger than the cost of building it can be done by auctioning the right to do it and regulating the delivery (see mobile telephony or toll roads). There's usually little benefit in the taxpayer running these services directly.

    For projects whose benefits are not tangible, is the cost benefit analysis worth it? Many of these projects are really consumption (nice to have but not in an obvious way cash positive) and should be accounted as such. Is HS2 consumption or investment? Was the cost/benefit study worth the paper it was printed on?

    1. The answer is rent-seeking and/or gaming the regulator. Broadband rollout could be considered as one example. BT/Openreach show every sign of doing the minimum work for the maximum cost, and we're at best ending up with a patchy system that lags behind other countries.

    2. Regulatory capture is a problem, but then the very same problem exists between the Treasury and government agencies. Some things are harder than others to delegate, though broadband may not be a particularly good example of a hard one. Old school state telcos were pretty good at patchy service too. (And do you have hard evidence of the alleged "lag" compared to other countries? Seems pretty average to me, which is as it should be.)

    3. Here for example.

  7. Correction on concept:

    The deficit spending is actually independent of your agreement.

  8. What if: a) political constraints mean that just financing the investment through borrowing is less feasible than through PQE and b) PQE is simply used to offset borrowing, so investment doesn't have to wait?

    That doesn't seem so crazy?

    1. Why do you think that monetary financing of government spending is more feasible than government borrowing, when it is actually illegal under EU law?

      Why do you think that people who object to the government borrowing to invest would be happy to see the government creating money to invest? All the evidence so far is that they are not happy with either.

      Why do you accept that there are political constraints on government borrowing, but not that there are political constraints on government money creation?

    2. Thanks for replying.

      I don’t have strong views on any of these things, I’m just interested in what you would think of it if as a potential second (or third or fourth or...?) best option. So it’s a hypothetical question - please add to it: (c) European law issues could be got round 

      For what it’s worth though. I do think it’s probable government borrowing is MORE politically constrained than some kind of PQE. Most people have accepted and won’t budge from the household spending narrative. Obviously “let’s just print the money” is a hard sell too, but I think “we’d use it to invest instead of giving it to the horrible bankers” could get some traction – lots of people are annoyed that and don’t understand why bankers were bailed out.

    3. Another thought. Moving the discussion onto this kind of a thing could go some way to denting the household analogy.

  9. Economists know we need to spend the money. So imagine a government that agreed and wanted to build for the future and assume it considered that the necessary real resources to do this exist and did indeed exist. To mobilise these it expands its balance sheet, issuing either: 1. negotiable coupon paying maturities (bonds), or 2. negotiable zero coupon perpetuals (currency/reserves). Given that people can swap these at the central bank they, the non gov’t, will determine the composition of the outstanding stock at the price the bank sets. If that price falls to zero, maybe because incomes cannot support further credit growth, then the two types of issue become functionally equivalent and monetary policy is exhausted together will all pretence of central bank independence. So call it whatever you like, any name that suits you: Overt monetary financing, Helicopter money, Conventional borrowing, QE, QE with central bank losses and treasury recapitalisation guarantees, Peoples QE, etc etc etc, the only question then is which variation of the same fundamental operation gives the least rent for the biggest bang. Peoples QE is the closest we’ve got yet. It might even work politically, hence the frantic attempt to stamp it out.

  10. Increase costs Now more like
    Problem is the UK is a capitalist economy - I.E true owners and workers / capitalists outside the loop are divided although the latter think it's between themselves.
    Labour is well labour in name at least (a sort ofcredit bankers teachers Pet) and the official owners of capital represents the other side of the house

    The problem is perhaps the nature of the division itself.......... The parliament is the oligarchyal force which represents this division in official political form.

    Problems in England go back far too long and are far too deep.
    A distributist voice which rejects the deep historical merger of state and capital nearly 500 years ago now is unlikely to be heard today.
    It's quite plausible to accept the place is too far gone down the rat hole for that.
    As capitalists now depend almost entirely on capital inflows from outside the political border the labour party is no longer correctly named.
    Their labour is not required anymore.
    This perhaps explains the currentl farcical nature of politics in this large city state where England is the green belt.

  11. How would government borrowing to invest increase its deficit? Through the yield payments to bondholders only, or is there also another link I am missing?