Causes of stagnation

Ben Chu reports that business investment has been “considerably weaker” than the Bank of England had expected “due to fears over a Brexit cliff-edge for trade.” The Bank, however, has a history of over-predicting capital spending. In November 2014, for example, it predicted that business investment would rise 10% in 2015. In fact, it rose only 3.7%. And that was in the happy days before we knew about Brexit.

This is not an idiosyncratic failure by the Bank. My chart shows the OBR’s record at forecasting business investment, comparing forecasts made in November or December for growth the following year to the out-turn. In only two of the last eight years has investment exceeded expectations. In one of these years (2014) the excess was tiny, and in the other (2017) the OBR seems to have over-estimated the damage Brexit uncertainty would do.

Of course, over-optimism about 2016 can be attributed to firms delaying investment because of Brexit uncertainty. But the OBR was over-optimistic for most of the 2011-15 period too. That can’t be blamed on Brexit.

The OBR and the Bank have for a long time thought that high corporate cash balances, a small output gap and high profits would stimulate investment. This has proved too optimistic. Why? Here are six possibilities:

 - A fear of technical change. If you invest in new robots, you risk being undercut in a few months’ time by a rival who has invested in cheaper or better ones. The prospect of rapid technical change can retard investment. This explains the paradox that there’s lots of talk about new technologies such as AI and robots but little investment in them.

 - Intangibles. As Stian Westlake and Jonathan Haskel have shown in Capitalism without Capital companies’ assets – and especially the assets of growing companies – are increasingly intangible: things such as good ideas, brands or firm-specific technologies and skills. These are lousy collateral. Which means it’s hard to finance for expansion. For this reason, firms must build up cash piles not only to finance future investment but to ensure that they have future cashflows if things turn bad – so they are in effect self-financing. This means that rising cash holdings aren’t as predictive of capital spending as they once were.

 - Illusory capital constraints. Increasing capacity constraints don’t necessarily boost investment as much as the Bank or OBR has thought. A study (pdf) of a steel mill by Igal Hendel and Yossi Spiegel  showed that it doubled production over 12 years with the same plant because every time the mill seemed to be at “full capacity”, its managers found ways of tweaking production methods to eke out more output. “Capacity is not well defined,” they conclude. If this is true of an old economy steel mill, how much more true is it of intangibles-intensive companies that are more scalable? The “output gap” might not be a useful idea.

 - Irrelevant profits. Profitability has been high recently, according to official figures at least. But this tells us only that past investments have been successful. It doesn’t necessarily tell managers much about the likely success of future, different projects.

 - Low wages. Sustained low wage inflation means firms have had little reason to replace workers with capital.

 - Learning. In the past, investments have often proved unprofitable. Charles Lee and Salman Arif have shown that rises in capital spending lead to earnings disappointments, in part because firms have underestimated how hard it is to maintain profits while expanding. To the extent that managers have learned from these mistakes, capital spending will be lower now.

None of this is to deny that Brexit uncertainty is depressing investment: we know that uncertainty causes firms to put projects on ice. What it does mean is that there are many other reasons for weak capital spending. Our obsession with Brexit is distracting us from the fact that there are deep structural reasons why British capitalism is stagnating.

Comments

[Tim Bassett]

Would add increasing operational due to technology leverage means firms have to reduce financial leverage to compensate.

A lot of modern plant has almost zero variable costs

[Callum]

Perhaps comparable to the steel mill example; I work in the financial sector and the go-to ways to improve productivity have been software changes (to improve output per person - a surprising amount just from removing bugs) and out-sourcing (to reduce costs). Are these captured in the Out-turn numbers?

[Robert Mitchell]

Why are economists so concerned about increasing investment? It's like you've all been trained to maximize an abstract number, and that will magically create well-being. You assume more is better; but that crass materialistic attitude sickens the non-neoliberals left among us. I don't want an abstract number like business investment to be the focus of public policy. Businesses externalize too many costs on the nature I try to escape to, to get away from your conspicuous consumption, your vast waste production, your pollution, your shallow, fickle, arbitrary social rules.

Public policy should leave business investment alone, not even track it. Let us self-provision in ways markets won't research because business is too focused on short-term profit.

Woz should never have met Jobs and continued sharing his designs for free. Neoliberalism has polluted the internet with tracking and ads.

[georgesdelatour]

https://www.brown.edu/academics/economics/sites/brown.edu.academics.economics/files/uploads/paperdemographics_automation_daron.pdf

In this paper, Acemoglu shows that Japan and Korea, which have ageing and shrinking workforces, are the ones most enthusiastically embracing robotics; while the UK and the US, which have far more buoyant labour markets, are lagging behind.

I’m reminded of James Belich’s somewhat ghoulish theory, that it was the Black Death which effectively kick-started the “Rise Of The West”. Here’s my crude attempt to summarise Belich’s argument:

Previous disasters, such as the Barbarian and Mongol invasions, killed a lot of people, and also did a lot of damage to capital and other non-human factors of production: government, infrastructure, land, livestock, buildings etc. The Black Death was different. It halved the population, but left everything else as it was. So once the plague was over, you had a society with effectively double the amount of capital per human. A society with capital to spare but a massive shortage of workers was far more likely to innovate with labour-saving inventions, such as printing.

I don't know if Belich is right, but the argument sounds plausible.

[dilbert dogbert]

This might interest: https://equitablegrowth.org/equitable-growth-in-conversation-david-weil/
One might conclude that corps are becoming hollow and only invest in the "Brand".
In the hollow corp maybe the paths for information about improved processes is blocked and does not reach the decision makers.

[Blissex]

«a steel mill by Igal Hendel and Yossi Spiegel showed that it doubled production over 12 years ... “Capacity is not well defined,” they conclude.»

Actually capacity is a fairly well defined quantity, for given levels of risk and plant lifetime.

There is always "fat" to cut where "fat" actually means some variant of "quality"; peak "pull all stops" capacity no more valid than sustainable "minimize risk and wear" capacity.

In thatcherite times clever managers always maximize revenue now at the cost of more trouble later, when it is someone else's problem.

[Blissex]

«work in the financial sector and the go-to ways to improve productivity have been software changes (to improve output per person - a surprising amount just from removing bugs) and out-sourcing (to reduce costs).»

Out-sourcing does not improve productivity, it improves margins, a very different concept. Productivity is physical output divided by physical input, such as ours of work, not by cost of input.

Switching from workers paid $20/hour making 12 widgets per hour to workers paid $5/hour making 6 widgets per hour both reduces productivity (making widget takes double the work) and increases margins (wage per widget halves).

[Blissex]

«corps are becoming hollow and only invest in the "Brand".
In the hollow corp»

Anglo-american culture corps are run by marketing and finance and they consider development, production etc. as costs to eliminate as stupid irrelevancies.
So they always try to get rid of them to become just toll-taking intermediaries, with the goal of getting pure "passive income" (rent) from licensing of brand and IP thanks to government "protection".

Also anglo-american corps have been told by anti-union consultants that worker unions tend to "infect" those industries that have large concentrations of workers in capital intensive plants, so they love the old practices of "putting out" and "piecework".

In the growing economies instead corps are far from hollow and they see their competitive advantage as being well managed tight organizations.

[Blissex]

«business investment has been “considerably weaker” than the Bank of England had expected»

I guess that it is unsurprising that the "sell-side" Bank of England tends to be always optimistic for the benefit of the stock and property markets, with rare exceptions as in "Project Fear".

[John Company]

Isn't the problem that the planning system is artifically maintaining lots of rotten, decaying cities? If you abolished planning controls tomorrow, you'd probably see places like Oxford, Cambridge, York and Bristol swell up.

[derrida derider]

I'd put most of the emphasis on low wages, simply because this is clearly a self-reinforcing equilibrium (as a long literature on the relations between wage growth and capital investment consistently shows). Who'd invest in a robot when humans are cheap?
In that Solow production function y=f(A,K,L) K is actually itself a function of L (as a Marxist like Chris must agree). But more significantly, so is A.

[Blissex]

«you'd probably see places like Oxford, Cambridge»

The centerpieces of both town receive 40-50% of all UK university and research spending, and the booming property prices and rents in both are entirely government created.

«swell up.»

But why would those cities swell up like the magic London-Oxbridge triangle? People don't move to London etc. because of the beaches, the relaxed culture, the sunny weather, the low cost of living.
People move "because jobs", whether they be immigrants from Cumbria or from Slovakia.

The London-Oxbridge triangle gets massive government support, and as a result it is heavily congested -- what would cause millions of jobs to move to Bristol or York other than a large change in government policy?

[Callum]

I absolutely agree that is the primary motivation, and don't dispute anything you have said. However with an international work-force opportunities arise to provide improvements in the product or service. The concept in finance of chasing the sun sees work passed from region to region in order to deliver at the earliest possible time. This I would argue is a productivity improvement through creatiive use of geography.

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