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July 25, 2005

David Willetts

A lovely little piece of sleuthing by David Willetts here.

The Chancellor's response is to say that we are still growing and that business is investing at a record rate. But somehow the real economy does not seem to be doing as well as his figures appear to show. I have been investigating and the results are revealing. As Mr Brown states every year in his Budget speeches, business investment is key to sustaining growth. He is right: it generates future income. He regularly claims, as he did in the last Budget, that "real business investment" is high and increasing. However, this claim hides several crucial distortions, the most important of which is the manner in which he measures increased investment - not the amount of money companies actually spend, but rather he tries to measure the amount they would have spent in 2002.

This sounds sensible as a way of measuring the volume of investment but actually it flatters his figures. IT and telecoms constitute around 17pc of business investment. Moore's Law (coined by Intel co-founder Gordon Moore) states that computing power doubles every 18 months, so a company might have bought a 1GHz processor chip in 2001 and replaced it with a 4GHz chip in 2005, paying about the same price. This will appear in Mr Brown's statistics as a quadrupling of "real" spending on business investment.

These sorts of adjustments, often used in trying to calculate inflation rates, go under the rubric of "hedonic". Sometimes they’re valid, sometimes not. But this really does appear to be one of the times when it is not valid. Certainly, no one really thinks you get 4 times the performance out of a 4 GHz chip, especially if you are running the latest piece of Microsoft bloatware. The real figures, not adjusted:

For example, after a historic low of 10pc of GDP in 1993, investment rates bounced back strongly and reached 12.5pc in 1998 (compared to an average of 12pc since these records began to be collected in 1965). Thereafter, all the usual historical relationships broke down. Despite macro-economic stability, the proportion of our national income which our businesses invest has fallen every year since then.

While the Chancellor claims investment rose, it actually fell from 11.5pc to 9.5pc, the lowest it has ever been.

This might explain something else, the way in which companies are throwing off cash. If business investment is falling, profits earnt have to go somewhere. Dividends, share buy backs and paying off loans has to be where.

July 25, 2005 in Economics | Permalink


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"Dividends, share buy backs and paying off loans has to be where" And reducing pension deficits?

Posted by: dearieme | Jul 25, 2005 10:09:45 AM

Returning cash to shareholders is a bad thing?

Have you been reading too much Keynes?

Perhaps levels of M3 being over the Investment rate is a sign of falling real economic growth.

Gordon's stealth recession is catching up with him.

Posted by: Rob Read | Jul 25, 2005 1:00:16 PM