Welcome back the Macmillan gap

Yesterday’s Budget revived an issue which I thought had died years ago - the relationship between finance and industry. Many of Darling’s measures - such as the University Enterprise Capital Fund, the green investment bank and targets for nationalized banks’ lending - are, in effect, saying that the job of financing investment cannot be left to the free market, because the financial system, on its own, will not adequately support innovative businesses.
This echoes ancient complaints about the UK banking system which go back at least as far as the Macmillan committee which complained in the 1930s that banks were not financing small business well enough - a view which persisted into the 1990s, when Will Hutton wrote in The State We’re In:

Disengaged, uncommitted and preoccupied with liquidity, the financial system has been uniquely bad at supporting investment and innovation.

This view, however, died out soon after Will wrote those words, perhaps because the world became flooded by cheap and easy money, some of which found its way into real businesses.
The distinctive feature of the Budget is that it has resurrected the idea. This is despite the fact that the world is still awash with cheap money; the IMF reckons the global economy will generate over £9 trillion of new savings this year - which is why index-linked gilt yields are still under 1%.
If I were Darling, I’d have made more of this. He could have said explicitly:

The legacy of the crisis is that bank lending criteria will be tighter in the next few years. And the lesson of the crisis is that banks are terrible judges of good and bad investments, so there’s no reason to suppose that lending will flow to genuinely profitable opportunities. Our financial system is so dysfunctional that it is unable to convert massive global savings into genuine productive investment.

So, should we welcome Darling’s return to mid-20th century orthodoxy, as Hopi does? I’m not sure. My concern is that, generally speaking - there are of course exceptions - our lack of capital spending might reflect not a lack of finance, but rather a “dearth of investment opportunities.”
Could it be, then, that Darling is repeating an old error of social democrats - he’s assuming that capitalism's troubles can be solved by technocratic fixes?

Comments

[Mike Woodhouse]

I'd say that the financial system most likely does support innovative businesses, but where those businesses are not able to demonstrate creditworthiness, it's not the banking part of the system that provides the support.

Financing innovation appears to be, generally speaking, a fairly tricky business. The strike rate for specialists in the field, which I suppose means venture capitalists, is fairly low, so VCs take lumpy equity stakes in order to get paid off. When it's an obvious sure thing, I'd expect loan financing is relatively straightforward.

I'm certain that innovators would much rather get load funding than give up equity (and I have a few innovative ideas that I'd be more than happy to get loans on were that to be possible) but the risk-reward in such cases is hopelessly skewed.

[luis enrique]

does the financial crisis really teach us that banks are bad at making corporate lending decisions?

[vimothy]

I don't think that the social democrats actually were in error. The problem with all the prices clear markets platitudes is that labour is both supply and demand. When wages fall, demand falls, because income is spending.

If the non-government sector (consolidating households, businesses and johnny foreigner) wants to save net of investment X amount of income, the government has to net spend that amount of money. The current government needs to spend a lot more, which will supply the net financial assets desired by the non-govt sector and support aggregate demand, bringing us back to somewhere near capacity.

The govt is totally essential to this.

[Allan Jones]

Surely the 'dearth of investment opportunities' theory is inconsistent with the investment needed to achieve the government's extremely ambitious carbon reduction goals. In this case at least, the investment opportunities are there, but perhaps there's not enough certainty about future policy regimes (e.g. for carbon pricing) for the private sector to take them. Hence a part-public funded 'green investment bank' to make up for this deficiency in government's ability to make credible long term commitments. (It will be fascinating to see how this bank shares risk between public and private sector - I suspect the only way it will work will be for the public sector to get a raw deal.)

[guthrie]

I'd agree straight away that capitalisms troubles can't be fixed by technocratic magic.
But that aside, that investors chronicle article says:
"In the long run, economic growth depends upon labour productivity, which in turn depends heavily upon investment in new equipment and techniques. If this investment is lacking, the economy will grow only slowly."

Which reminds me that we are now a service economy, not an industrial on, therefore you can't improve labout productivity as much or as quickly as you can industry, because automating and making service sector jobs more efficient is surely much harder and slower than in, eg, mining or manufacturing. Now we can build plants controlled by two guys watching computers and a dozen maintenance engineers, whereas before there would have been 200 people working there. But one call centre person or one lawyer can only talk with one client at a time, so it is harder to make improvements there. Although I suppose that's why they are using voice recognition software and asking questions of you the customer before they connect you to a human.
(And I bypass voice recognition by making random noises until the machine gives up)

[guthrie]

And 9 trillion of savings? How much clean water could that provide? How many solar, nuclear, wind and water plants could that build? How many hospitals, roads, schools. What if we could divert some of that to scientific research, rather than cutting the budgets of said research?

[Leigh Caldwell]

There may well be a lack of investment opportunities in which private investors can capture enough of the surplus to make a positive (risk-adjusted) return.

Even if this is true however, one of the characteristics of innovation is that it typically has large positive externalities: spillovers to other people and other firms when the new knowledge leaks out. Government has a valid role in subsidising positive externalities, and so it could well be economically efficient for them to invest in things which the private sector wouldn't.

Apart from this, there is a strong argument for multiple equilibria, where government action can shift the economy into a better equilibrium.

[Hopi Sen]

Another argument might be that by making investment more attractive (via tax credits, SEZs, angel invest help, etc etc) you help solve the "dearth of opporunities" by making marginal decisions a better deal.

On that basis, the technocratic fix is more on deciding which industries, research and regions should benefit from more help. This isn't perfect, but given clustering and limited resources, might be effective at generating employment and innovation.

Or to put it anther way, - was there a dearth of investment opportunity in the Pearl River delta until the Chinese made it attractive to invest there?

[Top Grade Acai]

very informational... educative as well, i read and felt like reading over and over again....good job!