Ever wondered why the UK is the 5th largest economy even with low investment?

The Bank of England’s new man offers a truly intangible attraction

david smith

When pictures appeared on front pages of the actor Aidan Turner, who plays Ross Poldark in the BBC series, it was followed by mild controversy. People, it was said, were taking notice only of the man, and his bare chest, rather than the actor and the part he was playing

Bear with me. Also a few days ago it was announced that Jonathan Haskel, of Imperial College London, had been appointed to the Bank of England’s monetary policy committee. Even without baring his chest, all the attention focused on the fact that he was a man and had been chosen from a shortlist of five; and that the other four were women. Little attention was devoted to him as an economist.

The fact that Professor Haskel was chosen in preference to other candidates was all about his potential ability to reshape the Bank’s thinking on key challenges for the economy, including low investment and weak productivity. In welcoming his appointment, both Philip Hammond and Mark Carney singled out his work on productivity and innovation.

He was the author, with Stian Westlake, of Capitalism Without Capital, named as one of the books of 2017 by both The Economist and America’s National Review. I reviewed it at the end of last year. It highlighted the importance of “intangible” investment in the economy, as distinct from “tangible” investment.

Tangible investment includes what we usually think of as investment — plant and machinery, buildings, IT and vehicles. Intangible investment, which overtook tangible investment in magnitude in Britain in about 2000, includes software, databases, research and development, the creation of original works of entertainment, literature and music, design, branding, training, market research and the re-engineering of business processes.

That there is both tangible and intangible investment is not new, but the implications are far-reaching. Official statisticians are trying to catch up with the importance of intangibles but have yet to do so. And while Britain’s record on conventional, tangible investment is awful — the lowest as a proportion of gross domestic product of more than 30 OECD countries in 1997-2017 — the performance on intangibles is better. According to Professor Haskel’s figures, Britain’s intangible investment is notably higher relative to GDP than most big EU countries, including Germany, France, Italy and Spain, and only a little lower than the leaders, Finland, the United States and Sweden.

His other finding is that intangible investment drives productivity growth. Tangible-intensive industries tend to achieve steady returns. Those that are intangible-intensive expand, get more productive and achieve increasing returns. Those companies that are at the productivity frontier — that are significantly more productive than the average for their sectors — are those with the highest levels of intangible investment. We need more tangible investment, including in infrastructure, and the debate is now joined about whether Heathrow’s third runway is the right kind of such investment. But we also need intangible investment.

This has implications for public policy, so, if the aim is to improve productivity across the economy, as much effort should be put into encouraging intangible investment as has been put into boosting investment in machinery, vehicles and commercial property. Some of that is done already, such as through the R&D tax credit. More could be.

The second implication is for spare capacity in the economy. The rise of intangible investment means that estimating spare capacity by reference only to traditional investment looks so last century. It is plainly more complicated than that and, as David Owen, an economist with Jeffries International, puts it, Professor Haskel’s expertise “may prove invaluable in helping the MPC better assess spare capacity in the UK economy and the rate of trend growth, both key when looking at monetary policy”.

They are indeed. The Office for Budget Responsibility, in setting the parameters for the government’s fiscal policy — tax and spending — and the MPC in deciding on interest rates and the other aspects of monetary policy have taken a gloomy view of the economy’s “speed limit”. Both think there is little spare capacity and that the economy’s trend rate of growth, its speed limit, is only about 1.5 per cent a year; little more than half what it was before the financial crisis.

These things can never be set in stone. In a services-based economy, it may be that output can be increased quite quickly with barely any increase in tangible investment. As long as people have the expertise, a mobile phone and a laptop may be all they need. They may not even need an office. Despite weak investment, the capital constraint on raising economic growth is less than it appears to be.

That leaves people; the labour constraint. Pretty well every business survey shows recruitment difficulties and skill shortages, which may partly explain the strength of the job figures; employers are recruiting when they can. The Bank tends to focus on the unemployment rate, presently a low 4.2 per cent, as the best measure of spare capacity in the economy.

There was a time when this seemed like an unnecessarily limited approach. Employers had access to a labour market that encompassed the EU, a key ingredient of Britain’s flexible labour market. But that is changing. The number of EU workers has dropped over the past year. Even before we leave the EU, the flow of workers has slowed significantly to half its pre-referendum peak.

To grow, Britain needs tangible and intangible investment and the latter suggests that there may be more slack in the economy than thought. Yet we also need a flexible labour market and a free flow of migrant workers. There, things are more difficult.

David Smith is Economics Editor of The Sunday Times
david.smith@sunday-times.co.uk