GDP growth? Public sector cuts explain why business failed to invest

The OBR's reasons for lack of GDP growth originated from a government policy leaving business leaders without a life raft
Public sector cuts
For business leaders, public sector cuts, and the rhetoric that went with them, killed off the idea that the government was standing behind the recovery. Photograph: Paul Doyle/Alamy

The government's independent economic forecaster says optimistic predictions for GDP growth it made in 2010 were off target because businesses failed to invest as expected.

In a look back at its record since the last election, the Office for Budget Responsibility wants to set the record straight. It says public sector cuts hurt the economy and exaggerated the recession, but no more than expected (Jonathan Portes at the National Institute of Economic and Social Research discusses this in his latest blog). The unexpected came from a different quarter. It was the private sector's refusal to put its profits to work by buying new equipment and processes.

In 2010 the OBR boldly claimed a business investment boom was imminent as firms looked to capitalise on the shake-out from the recession. Opportunities from a rise in export orders and increased consumer demand would drive the investment cycle into an upswing, went the story. Once in train, business investment would drive GDP back above its previous peak and end the depression.

It didn't happen. UK GDP is still 2.7% below its peak. That a lack of business investment wrecked the OBR's forecasts is obvious. That it undermined GDP growth is also pretty obvious.

The grittier problem, one that needs more digging and sifting, relates to why business investment has sagged and, according to the latest data, is still falling.

The OBR blames the eurozone crisis and the inflation spikes borne of commodity price shocks. In addition, lower than expected corporate profits and uncertainty about government policy played a part. According to this view, businesses were paralysed by a bleak world economic outlook.

But there is another view:

1. What we know about investment is that it is mostly carried out by larger companies and their profits bounced back quickly from 2011. For some time now they have sat on a cash mountain.

2. Commodity inflation is a problem, but has been offset by low wages, which have kept input costs in check.

3. The eurozone crisis was difficult, but effectively ended in July 2012 when the European Central Bank said it would underwrite every country to save the euro.

4. The OBR mentions that uncertainty over government policy was a factor. Surely this underplays the conservative risk/reward debate that goes on in every boardroom.

It underplays the effect on what the economist John Maynard Keynes referred to as animal spirits? There are many of us who had their head in their hands when George Osborne embarked on his Broken Britain campaign and capped it off in his first budget by likening Britain to Greece. David Cameron did it again in his recent Tory conference speech. Vote Labour and you'll be voting for Greek-style bankruptcy, was Cameron's message.

Austerity, as Portes points out, probably hurt the economy more than the OBR believes. And an easing in the pace of cuts has helped lift the economy in the last year.

Yet public sector cuts, and the rhetoric that went with them, killed off the idea that the government was standing behind the recovery. An ideological commitment to reduce public sector spending to clear the path for private sector firms left business leaders swimming without a life raft. The safety first reaction of many businesses, hoarding cash and cutting investment, betrayed the entrepreneurial spirit that justifies executive bonuses, but more importantly gave the lie to claims by free marketeers that, given a clear path, businesses will take a risk.

With infrastructure spending cut in half in Osborne's first budget, businesses rightly took the view that the fabric of our transport networks, education system and health service would soon begin to fray.

It could be that the business sector, already using outdated software and ageing equipment, is about to embark on an investment spending spree. It could be that just as debt-fuelled consumer spending begins to wane, the business sector steps into the breach. Manufacturers' association EEF and accountants BDO said on Monday a balance of 24% of companies intended to buy machinery and equipment, up from 7% in the May poll.

Yet it is also possible that a large proportion of our largest firms will make their new investments abroad, in countries less weighed down by debts, with better growth prospects and governments that invest in infrastructure. Government investment is complementary to private sector ambitions and allows firms to increase productivity. An administration that cannot understand how a modern economy is intertwined in this way will be abandoned, not rewarded by the business community.