Government spending won’t fix the economy

WHEN looking at investment data during the recent recession two key things emerge. The first is that UK investment (or “Gross Fixed Capital Formation”) has not fully recovered (see top chart, below). It did bounce back, but once more the growth rate is negative.

However, to understand what is going on, it’s important to look beyond the headline figure, and study the composition of investment.

The second key lesson from the output data is that the recession saw a massive shift from private investment spending to government spending (see bottom chart, below).

GFCF is comprised of the sum of business investment, general government, public corporations, and private sector dwellings. The chart shows how “private investment” (business investment and private sector dwellings) was mitigated by increases in general government investment.

The Keynesian view is that governments can boost aggregate demand with government spending when investment is too low. But there are well known problems with this. Put simply, £1m of government spending is not the same thing as £1m of private spending. Chinese ghost cities have the potential to increase GDP, but at the expense of genuine economic development.

When private sector investment declines, then the reasons need to be identified and a solution found. The key policy question needs to be “why aren’t businesses investing?” Attempting to offset it with government spending is just an accounting deception. And too much government intervention can be the underlying cause, not the cure – through high tax rates, burdensome regulations and policy uncertainty.

Successive interventions destabilise the climate of investment, exposing the folly that government can simply step in and replace it. The only way forward is to focus on reducing barriers to business. It is production that gives us the power to consume, and it is private sector production that needs to recover.

Anthony J. Evans is Associate Professor of Economics at London’s ESCP Europe Business School, and Fulbright Scholar-in-Residence at San Jose State University. anthonyjevans.com