Sean O’Grady: Ministers must try to avoid making schoolboy errors on investment

The worst mark I received during my all-too-brief brief study of economics was on an essay about how to boost growth in an economy. Feeling rather pleased with myself, I had written what I considered a damning indictment of the way the post-war British economy had been run. The usual stuff, in other words. Short-termism in the City: "Fred Kite" shop stewards; dilettante management; weak design; takeover laws; historic failure to train sufficient engineers; snobbiness about industry; over-regulation; not being in Europe.

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My tutor returned it with a mark so low that I'm ashamed to mention it even now. He scrawled "INVESTMENT!" across the front page of my script. I'd forgotten to mention investment. Rather foolish, that. I learnt my lesson.

So should ministers. My old economics teacher was probably right in his verdict on my work, but I'd still maintain that the Thatcher/Major era programme of trade union reforms, privatisations, liberalisation of the City, and reductions in marginal tax rates may have boosted the long-term growth rate somewhat.

But such measures can take decades to make their effects known, and it has to be a substantial body of reforms, as the Thatcher programme was.

"Growth reviews" of the kind published and to-be-published by the Department for Business and the Treasury are essentially micro-measures that cannot, even on the most generous view, compensate for the investment strike now going on in British industry and commerce.

You are not going to boost productivity very much by scrapping maternity rights or by abolishing consumer rights. Nor by a one-in-one-out red tape regime, or by replacing Regional Development agencies with Local Enterprise Partnerships, or by a Green Investment Bank or any of the hundred other little schemes the Government proposes, useful as they are. Reducing the age limit to buy Christmas crackers or making it easier to sell a Toilet Duck is also unlikely to lift the long-term growth rate.

The point of investment is to improve the capacity of the economy to improve its producti- vity, and to capture the gains from technical improvement that happen almost naturally.

The delivery van of today is quicker, more economical to run, less rust-prone and generally more productive than its counterparts from the past – and cheaper with it. That is progress, but you take advantage of that only if you invest in a new fleet of vans.

Investment thus means enjoying better human and physical capital, and having improved ways of putting it to work. It means new machinery and plant; new laptops; new and more powerful web servers; more efficient and greener power generation; better infrastructure such as road, rail and airports.

So what's happening to investment? Well, the trends are disturbingly weak. Right now, British business is sitting on a £60bn cash pile, some 4.5 per cent of GDP, too frightened to spend it on new kit because they don't know what's round the corner.

What's more, business investment is in long-term decline, on a quarter-century view, and that is not promising. In the past decade or so it has been hidden by some substantial government investment, but that is now set to shrink sharply. According to the CBI's latest forecast private sector investment is due to grow by an annual rate of about 9 per cent over the next year or two – if companies can summon up the gumption to do so, and on a low base.

But the really startling trend is in government fixed investment. While certain high-profile projects such as the fast link to Birmingham will be protected, many others, not least the Building Schools for the Future programme, have been cancelled. So government fixed investment is due to shrink by an annual rate of 10 per cent plus in the coming months.

We don't have the breakdown on the second quarter's GDP figures yet, but what seems to have been happening in recent months is firms have become increasingly nervous about committing to expanding capacity. One of the most disturbing aspects of last week's CBI Industrial Trends Survey was the slump in the number of companies planning to expand facilities in the next few months. Investment in the service sector may prove more resilient – but again it calls into question the speed and extent of the "rebalancing" of the economy towards manufacturing. Quite simply, we are not investing in it, so it is unlikely to grow.

All of which makes one wonder about the long-term growth rate of the economy, something that is notoriously hard to judge but crucial to any sensible conclusion about the extent of spare capacity in the economy, as well as to long-term prospects for living standards and international political clout.

For much of the post-war era it was stuck at about 2.25 to 2.5 per cent – slower than our European neighbours. By the 1990s it had tacked up to maybe 2.75 per cent – faster than the continentals. Now it seems set to return to its 1945-80 average. If it really is the case that the long-term growth rates will be closer to 2 per cent than 3 per cent, as many economists are now supposing, the consequences will be dire.

Much of that is down to our long term failure to invest – itself just the flipside of our tendency to over-consume and under-save.

At the risk of being provocative, I also ought to mention that one of the factors that boosted growth in the "nice decade" of 1997 to 2007 was the growth in immigration – more human hands make for higher GDP. Now that that has slackened off and is being capped, that too may knock a quarter or a half-percentage point off the growth rates – or the loss of around £5bn a year in output.

As in all economies at all times the British have a choice: consume a little less now and invest more, in the knowledge that our economy will grow faster than otherwise in the longer run, to the benefit of our heirs and successors. Or protect current living standards and consumption and skimp on investment, the devil take the hindmost and leave the future to look after itself.

So should the government promote investment at the expense of consumption? Purists would argue not, and that if the collective will of a society is to eat its seed-corn then it should be allowed to go ahead. Yet as a society we have obligations to future generations not around today to voice their protests.

There is a philosophical, moral case for the state to represent future generations' interests. Practically, that means higher taxes on consumption (such as VAT) to fund higher government spending on infrastructure (such as electricity supply).

When living standards and consumption are suffering their worst squeeze since the Second World War, that won't happen. It would be a schoolboy error to suppose otherwise.