Banks are to be provided with billions of pounds of cheap credit to lend on to companies. But this will not address the real problem, which is a lack of demand in the economy
In yesterday’s Mansion House speech, Chancellor George Osborne was under pressure to act on the economy. He announced that a lack of credit is damaging businesses and costing jobs. So, wheeling out the big guns, the Treasury and the Bank of England will take coordinated action to support as much as £80bn of lending in the economy to kick-start the recovery. But is it really a lack of credit that’s holding back the recovery?
Over the past two years, there have been a series of measures to increase the availability of finance to the business sector: Project Merlin, the National Loan Guarantee Scheme, and the Business Finance Partnership – all against a backdrop of loose monetary policy from the Bank of England.
But financial and survey evidence suggests that, at the moment, lack of credit is not the main barrier to growth for most firms. In fact, the business sector in the UK has been running a financial surplus, now sitting on top of a £754bn corporate cash pile that it doesn’t want to invest.
In aggregate, it is not lack of finance that is holding firms back from investing, but uncertainty about whether it makes sense to invest – if nobody wants to buy the widgets then why invest in producing them?
Could it be that small and medium-sized enterprises are in a different position to larger firms – wanting to invest but starved of credit? Survey evidence suggests not.
For example, the March edition of BIS’s SME business barometer showed that 32% cited ‘the economy’ as the main obstacle to the success of their business. Specifically, they pointed to uncertainty about the future and lack of demand from consumers. In second place, 13% cited tax as the main barrier. Only 9% cited ‘obtaining finance’.
Undoubtedly, the eurozone crisis has the potential to disrupt lending, so ensuring that firms do continue to have access to finance is important. But evidence strongly suggests that the dominant problem is a lack of demand in the economy. No amount of access to finance will raise investment if firms can’t see any customers.
If consumers and businesses aren’t spending, then government needs to engage in direct spending in the economy. Is this compatible with the deficit reduction plans? It can be, by changing the balance of public spending towards growth-friendly areas such as infrastructure investment, and away from low-growth transfers that take cash out of the economy (like benefits for better-off pensioners).
A switch like this, which the Social Market Foundation set out in a recent paper, would increase economic output without borrowing a penny more.
Keeping the credit channels open can only be a good thing. But unless the chancellor can conjure up some demand, he’ll find that the big guns are pointing in the wrong direction.
Nida Broughton is senior economist at the Social Market Foundation