Osborne's deficit reduction plan is more like a productivity reduction plan

Borrowing to invest is entirely sensible; if spending enhances capacity, it pays for itself

The Chancellor received only limited support for his deficit reduction plan from Christine Lagarde, head of the IMF (getty images)

"Money makes the world go around” sang the master of ceremonies in Cabaret. True enough in the short term, but what makes the economic world go around in the long term is the investment of money. It’s capital investment – locking money up today in a project that will increase the productive capacity of our economy tomorrow – that generates sustainable economic growth and puts more money in our pockets. And there are worrying signs that we’re not getting enough of it.

The evidence is accumulating that firms aren’t investing enough in things like new factories and fresh equipment. Every year, the credit rating agency Standard & Poor’s conducts a major survey of the world’s biggest companies to discern their capital investment intentions. And this week S&P reported that investment is likely to contract in 2015. It gets worse: this will be the third year of contraction in succession. And S&P says corporate investment will fall in 2016 too.

It’s not down to a shortage of money, either. The leading firms of the world have an estimated $4.4tr of cash on their balance sheets, earning miserably small return at this time of low interest rates. So what’s going on? Why aren’t these firms investing?

Andy Haldane, the Bank of England’s chief economist, recently suggested that there’s a “short-termism” problem in public stock markets. Too many modern shareholders, for a variety of reasons, want companies’ profits to be distributed to them as cash today, rather than invested for future growth. And many company managers, afraid of shareholders selling up, tend to give them what they want. The result is elevated share prices but weak investment. Haldane suggests changing company law to help reduce the influence of impatient shareholders over the strategic investment decisions of company managers. It’s a radical agenda, but one worthy of serious consideration.

However, the roots of underinvestment go deeper. Short-termism seems to have spread to governments in the advanced world too. Public investment is not the same as the private variety undertaken by firms; it tends to be spending on infrastructure such as road and rail links, telecoms and energy. But, just like private investment, this public investment boosts the productive capacity of the entire economy. Better transport links help goods and people move around the economy more efficiently. Faster broadband helps businesses expand. And try running any kind of commercial organisation when there’s a power cut because the generating stations are too old or over-capacity.

Yet the governments of the eurozone have been slashing public infrastructure budgets in recent years. The federal government in America has cut deeply too. And our own Government, under George Osborne, is part of this retreat.

The evidence can be found in his official fiscal targets. In 2010, the Chancellor had a target of wiping out the “current” budget deficit. This referred to day-to-day expenditure on things such as the salaries of teachers and nurses, and welfare spending. It excluded any borrowing that was needed to fund public infrastructure investment spending. But now Osborne has hardened this target considerably. He now wants to achieve an overall budget surplus by the end of the decade, not just a surplus on the current budget. This implies that all borrowing is equally undesirable, even if the money is spent on infrastructure investment. This is likely to be one of the reasons the Government recently announced that it will delay a number of promised rail modernisation projects for the North of England and the Midlands.

This is penny wise, pound foolish. Borrowing to invest is entirely sensible; if spending enhances our economy’s productive capacity, it ultimately pays for itself. The fact that future generations will benefit from infrastructure spending today also makes it reasonable to finance it through borrowing paid back over time (especially when record low borrowing costs are available).

Yet in last month’s Budget, the Chancellor quietly reduced planned public investment spending over the coming years. Public sector net investment spending is currently around £30bn a year, or 1.7 per cent of GDP. But it is now set to decline to just 1.4 per cent of GDP in 2020, which will be the lowest level of investment seen since 2003. The Chancellor likes to talk of his plans for a “Northern Powerhouse” of interconnected cities. Devolving power to local councils is a very good idea but there doesn’t seem to be much public money behind the grand plan.

Labour’s response to all this has been rather depressing. The shadow Chancellor, Chris Leslie, this week poured scorn on the economic platform of the surprise favourite for the Labour leadership, Jeremy Corbyn. He told The Independent that governments must “live within their means” and that “there is nothing left-wing about running a deficit in perpetuity”. But a quick scan of Corbyn’s proposals shows that the veteran MP actually says a Labour government should not run a current budget deficit after 2020 – but should be able to borrow to invest thereafter. That’s pretty much the same position Labour took going into this year’s general election. Mr Leslie gives the impression he thinks that position was mistaken and that he now agrees with the Chancellor.

Capitulating to Osborne’s plan to run absolute surpluses, ignoring the vital distinction between borrowing for investment and borrowing for current spending would be a serious mistake.

If Labour wants to show contrition for past mistakes it should apologise for pencilling in large cuts to public infrastructure expenditure in the party’s final Budget before the 2010 general election – cuts which Osborne implemented and which contributed to the feeble performance of the economy in the following years. There is a pressing need for politicians to make the case for more capital investment, both private and public. It’s good economics; it ought to be good politics too.