This morning, I got into a Twitter row with Jackart. He says: "State spending CAUSES lack of private investment." I agree with him that this can happen sometimes. But I disagree with him that it happened with Gordon Brown's fiscal loosening in the mid-00s.
My chart provides some background. It shows that in the mid-00s - well before the financial crisis - the government did start to run a deficit. And companies ran a surplus, with retained profits exceeding capital spending. It's also clear that, over time, these two financial balances have been mirrors of each other; the correlation between the two has been minus 0.77 since 1988Q1.
This poses the question: was it the government deficit that caused the corporate surplus? There are three ways in which it might have done - in which state spending might have crowded out private investment - but I don't think any of these mechanisms operated in the mid-00s:
- Financial crowding out. Government borrowing can raise interest rates which chokes off private spending. One simple fact tells us that this didn't happen in the 00s - real gilt yields fell; ten year ones dropped from 2.6% at the end of 2001 to 1.7% at the end of 2006.
- Ricardian equivalence. It's possible that companies saw rising government borrowing as meaning higher future taxes, and so cut investment for fear of a lower future post-tax return. If, however, the incidence of corporate taxes falls upon workers rather than profits, this mechanism won't have worked; even if firms did anticipate higher future corporate taxes (and I'm not sure this was true), they might have thought: "these'll reduce future wages rather than profits" which shouldn't have affected investment*.
- A wage squeeze. If governments hire more workers, wages will rise and this will squeeze profits and expected profits and so deter investment. This can happen; Silvia Ardagna and Alberto Alsina have shown (pdf) that sometimes fiscal contractions can raise growth because they cut wages and so alleviate a profit, so it's reasonable to suppose that fiscal expansions can sometimes do the opposite. But again, this did not happen in the mid-00s. As the IFS has pointed out, real household incomes (most of which are wages) grew very slowly then. That's the opposite of what should have happened if there were wage crowding out.
I suspect instead that the causality between the two financial balances ran the other way. A dearth of monetizable investment opportunities - because of, among other things, slower technical progress and the migration of low-wage industry to China - caused companies to reduce investment. This led to falling real interest rates and weak incomes growth, and increased government borrowing was the response to this.
Now, I'll concede that this story still gives Jackart many things to complain about. You could argue that the response to weak corporate investment should have been looser monetary rather than fiscal policy - though personally I suspect this would have increased speculation, house prices and malinvestments even more. Or you could argue that the fiscal loosening should have taken the form more of tax cuts than spending increases. And you can certainly complain that higher spending was accompanied by a lack of public sector productivity growth.
However, I just don't buy the claim that, in the 00s, Brown's fiscal expansion caused the lack of private investment.
* I suppose you could argue that firms cut capital spending because they thought that lower future wages would have depressed aggregate demand - but I'd welcome decent empirical evidence on this.