There’s a problem with Britain’s recovery. Everyone knows what it is. While overall GDP growth has been just fine, investment has not. Private-sector investment in the year to mid-2013 was a mere 13.7%.
That’s the lowest since the mid-1950s. Take out depreciation, says Liam Halligan in The Daily Telegraph, and it’s down to 2.4%. That’s a “disgrace”. Worse, it shows no signs of picking up.
As Patrick Hosking points out in The Times, it even fell by 2.7 percentage points from the first quarter of the year to the second. “When it comes to forking out for new premises, plant, machinery, intellectual property or IT systems”, it seems that British business is “parsimonious in the extreme”.
This matters. Only real investment in the kind of things that drive wealth over the long term can give us long-term growth (buying and selling houses to each other, just to be clear, can’t). So why aren’t companies investing? No one is sure.
It could be because there is plenty of spare capacity and they don’t need to. It could be because they aren’t confident enough to do so yet. It could be because they are having trouble borrowing. It could be because they can’t see anything worth investing in.
But there might also be another, much more depressing answer: the incentive packages we allow boards to award themselves. In his latest book, The Road to Recovery, Andrew Smithers notes that low business investment isn’t a new problem: instead it has risen hand in hand with the “profound change” in the way executives have been paid over the last 20 years.
His key point is this: thanks to the fact that options on the share price of a firm are now such a huge part of their pay – and can make them so very rich – the modern CEO runs his company with a view to pushing up short-term profits and hence the share price.
Investing reduces profits (as does paying high wages to staff), so they don’t do it. The result? Company heads are “rewarded for extracting short-term rents while running their companies into the ground”.
People react to the financial incentives they are given, so until we change those incentives we can’t expect to see rising investment – or sustainable recovery.
This brings me to RBS. The stunningly awful behaviour of its restructuring division (Global Restructuring Group) towards the firms in its care is a classic of the short-term rent-seeking genre.
There being no gain for the division in creating or attempting to hang on to long-term relationships with customers, it has every incentive to take what Felix Salmon of Reuters calls a “maximally adversarial stance” towards borrowers, causing a nasty amount of human distress, but providing a slug of extra short-term profit (and presumably bonuses along the way).
Again we see people reacting to the financial incentives we give them. Perhaps it is time to come up with some new ones.