Tuesday, May 29, 2012

Public Sector Net Investment explained

Government investment (or to give the full technical term Public Sector Net Investment) is the amount of money invested by the government on new infrastructure projects, things like hospitals, schools, army bases, police stations, motorway improvements and railway bridges. Anyone that has ever experienced publicly funded education at a state school or a public university, received treatment at an NHS facility or driven on a motorway has experienced the economic benefit of Public Sector Net Investment.

Increasing the amount of Public Sector Net Investment during economic downturn periods is a tried and tested method for boosting economies out of recession. Franklin D. Roosevelt boosted the US economy out of the post Wall Street Crash "Great Depression" by regulating the speculative activities of the financial sector and investing heavily in public infrastructure projects. After the Second World War, the UK economy was in ruins, with a national debt in excess of 237% of GDP, the establishment political parties agreed upon the post-war consensus and set about building hospitals, schools and social housing at an unprecedented scale and after three decades of the mixed economy of regulated capitalism and large scale state spending, the UK national debt had been reduced to just 43% of GDP. After Carlos Menem's government completely broke the Argentine economy with their diligent adherence to IMF pseudo-economic dogma and ceding their fiscal autonomy by linking their currency to the US Dollar, the Kirchner government restored economic growth of 9% of GDP per year, by closing tax loopholes and using the increased tax revenue to invest heavily in public infrastructure projects such as building houses, schools and hospitals, and improving infrastructure in areas that had been without basic utilities such as running water and electricity.

The reason that targeted public sector investment works as a short-term economic stimulus is that a lot of the government investment is economically recycled in the form of wages, tax contributions and private sector profits on the supply of materials and services. Public sector investment can also work as a long-term economic stimulus if the spending is done intelligently. The aim of public sector investment should be to establish strong fiscal multipliers. A strong fiscal multiplier is an expenditure that ends up creating more economic activity than the cost of the initial investment.

To give a very simplified fictional example; a government funds the development of a new power station in an area with unreliable power supplies. 40% of the construction cost goes towards the after tax salaries of the workforce (which adds to the amount of aggregate demand in the wider economy by boosting the disposable income of the workers)  30% of the construction cost goes towards tax payments (which can be recycled into the construction of other economic multipliers) and 20% goes towards the corporate profits of the construction and supply companies (which provides more wealth for shareholders and more capital for private sector expansion).

Once the power station is operational it acts as an incentive for several companies to locate themselves within the local economy to take advantage of the cheap and reliable electricity, generating more jobs and more disposable income, increased tax revenues for further public sector investment and more profits to stimulate further capitalist expansion. After the power station is decommissioned it can be estimated that the construction of the power station more than paid for itself, through increased economic activity, higher tax receipts and increased private sector investment in the area.

The Tory led coalition have decided to ignore the lessons
 of history and attempt to cure a recession by
slashing public sector investment.
Other fiscal multipliers include the funding of schools and universities (because educated workers are productive workers), the construction of hospitals and other health care investments (because healthy workers are productive workers), and the building of public infrastructure like road and rail links (since sitting in traffic jams or waiting for delayed trains is economically inefficient use of what could be economically productive time). Another surprising kind of fiscal multiplier can be direct welfare payments (such as pensions and unemployment benefits) which are generally spent locally, stimulating economic activity. An American study showed that the biggest one year (short term) fiscal multiplier of any US government policy in 2008 was actually achieved through the temporary increase in the provision of food stamps to destitute American families, with a fiscal multiplication effect of 1.73.

Public Sector Net Investment generally has a very high fiscal multiplier effect, especially investment in the construction sector. All of this seems to have passed the Tory led Coalition government by. Since they came to power in 2010 they have cut public sector net investment from 3.5% of GDP to 1.5% of GDP under the ideologically driven assumption that all government spending is inefficient if not completely evil. Effectively what they are doing is throwing the baby out with the bathwater. In in a drive to cut state spending at all costs, they are also cutting investment in areas where government spending is actually very efficient. At a time when the cost of UK government borrowing is extremely low, meaning very low interest repayments on money borrowed to invest in fiscal multipliers, the Coalition government have decided to ignore the lessons of history and drastically slash the amount of public sector investment in economically beneficial infrastructure projects in what is looking more and more like a barmy ideologically driven agenda than a coherent government strategy.

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