Tuesday, 13 October 2015

Why borrowing for investment is correct – John McDonnell is right & Osborne is wrong

By John Ross

An earlier article ‘Why John McDonnell is correct to borrow for investment – an elementary economics lesson for Osborne’ analysed in the ‘family’ and ‘common sense’ vocabulary Osborne likes to present the distinction between state borrowing for investment and state borrowing for current expenditure – a key economic distinction Osborne’s Fiscal Charter deliberately tries to obscure. It also showed how sections of the media deliberately attempt to aid Osborne in this by talking of budget ‘deficits’ and ‘borrowing’ without distinguishing between borrowing for investment and borrowing for consumption.

The following article, an excerpt from a longer analysis of Western responses to the Great Recession, analyses the issue in more formal economic terms. It shows that John McDonnell is very far from being an ‘extremist radical’ in supporting state borrowing for investment. Among those holding the same logical position are fellow 'extremists' Ben Bernanke. Larry Summer and Martin Wolf!

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An answer that may be immediately rejected in explaining the failure of response to the Great Recession, and the ‘new mediocre’ slow economic growth following it, was that no Western expert understood the situation. To the contrary, eminent Western economic figures well understood that the problem in the US and other Western economies was that the mechanism translating company income into investment was not functioning adequately, and that the solution was for the state to step in and invest these funds - as in Roosevelt’s 1930s response to the Great Depression. Merely a representative few of those arguing for this response will therefore be quoted - to show the accurate, indeed comprehensive, character of their analyses.

Ben Bernanke, almost immediately he could speak openly after ceasing to be Chair of the US Federal Reserve, called for:

‘a well-structured program of public infrastructure development, which would support growth in the near term by creating jobs and in the longer term by making our economy more productive.’1

Lawrence Summers, former US Treasury Secretary, argued:

‘We may… be in a period of ‘secular stagnation’ in which sluggish growth and output, and employment levels well below potential, might coincide for some time to come with problematically low real interest rates…

‘The… approach… that holds most promise – is a commitment to raising the level of demand at any given level of interest rates… This means ending the disastrous trend towards ever less government spending and employment each year – and taking advantage of the current period of economic slack to renew and build up our infrastructure. If the government had invested more over the past five years, our debt burden relative to our incomes would be lower: allowing slackening in the economy has hurt its potential in the long run.’2

Martin Wolf, chief economics commentator of the Financial Times, and one of the world’s most influential economic journalists, argued:

'In brief, the world economy has been generating more savings than businesses wish to use, even at very low interest rates. This is true not just in the US, but also in most significant high-income economies.

‘The glut of savings, then, has become a constraint on current demand. But since it is connected to weak investment, it also implies slow growth of prospective supply…

‘So what is to be done? One response to an excess of desired savings over investment would be even more negative real rates of interest. That is why some economists have argued for higher inflation. But that would be hard to achieve, even if it were politically acceptable….

‘Yet another possibility… supported by many economists (including myself), is to use today’s glut of savings to finance a surge in public investment.

‘The best response… is measures aimed at raising productive private and public investment. Yes, mistakes will be made. But it will be better to risk mistakes than accept the costs of an impoverished future.’3

Wolf analysed this situation in the UK, which faced the same problem as the US, citing similar views by other influential commentators:

‘With real interest rates close to zero… it is impossible to believe that the government cannot find investments to make itself, or investments it can make with the private sector, or private investments whose tail risks it can insure that do not earn more than the real cost of funds. If that were not true, the UK would be finished. Not only the economy, but the government itself is virtually certain to be better off if it undertook such investments and if it were to do its accounting in a rational way…

‘This does not even deserve the label primitive. It is simply ridiculous.’

Wolf clearly pointed to the consequences:

‘The results… are not at all ridiculous. They are extremely costly to both the economy and society. Yet, instead of taking advantage of the opportunity of a lifetime to repair and upgrade the capital stock, as Mr Portes [of the UK National Institute for Economic and Social Research] notes: “Public sector net investment – spending on building roads, schools and hospitals – has been cut by about half over the past three years, and will be cut even further over the next two.”’

Wolf concluded, endorsing such analysis:

‘He [Portes] recommends a £30bn investment programme (about 2 per cent of GDP). I would go for far more. Note that the impact on the government’s debt stock would be trivial even if it brought no longer-term gains…

‘the government… is refusing to take advantage of the borrowing opportunities of a lifetime…. It is determined to persist with its course, regardless of the unexpectedly adverse changes in the external environment. The result is likely to be a permanent reduction in the output of the UK.’ 4

Richard Yamarone, of Bloomberg Economics Brief, caustically noted:

‘Instead of adopting an economic solution such as matching idled and unemployed agents (millions of manufacturing and construction workers) with necessary improvements to the electrical grid, dilapidated highways, high-speed trains, outdated bridges, tunnels, ports, and water pipes, America received the political response of extended unemployment benefits and a whopping food stamp programme – safety nets for those who have fallen, not ‘stimulative’ measures.

‘Unlike during the Great Depression, which left a dazzling infrastructure legacy including a swath of bridges, tunnels, highways, art, dams and power generation, the only remnant from the 2007-09 depression is an underemployed labour force, earning a fraction of previous incomes, diminished skill sets and little or no promise for recent college graduates.’5


1. Bernanke, B. (2015, April 30). WSJ Editorial Page Watch: The Slow-Growth Fed? Retrieved May 2, 2015, from Brookings: http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/30-wsj-editorial-slow-growth-fed?cid=00900015020089101US0001-05011

2. Summers, L. (2014, January 5). Washington must not settle for secular stagnation. Financial Times.

3. Wolf, M. (2013a, November 19). Why the future looks sluggish. Financial Times.

4. Wolf, M. (2012, May 17). Cameron is consigning the UK to stagnation. Financial Times.

5. Yamarone, R. (2014, January 8). Summers’ remedy is years out of date. Financial Times.

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