A London School of Economics Press Release from last August cites two reports in which economists argue that record-low interest rates give an opportunity for government to undertake infrastructure investment. The claim is that this would boost growth, raise returns to private investors, strengthen the stability of public finances, reduce the risk of house-price ‘bubbles’… and have no impact upon inflation. Little wonder that, in the month following, John McDonnell should commit a Labour government to establishing a national investment bank, with £100 billion borrowed ‘at the cheapest rates in our history.’
There are a number of reasons why such arguments are misleading.
When large corporations borrow, they expect to make a return from which to repay the debt. Although governments may borrow more cheaply, this is because market participants understand that taxpayers underwrite the debt. That privilege may allow wider societal needs (including infrastructure) to be met with no market rate of return. When taken too far, credibility in the viability of such action can dissipate even to the extent evidenced by Greece, Venezuela and Zimbabwe.
A second objection to borrowing at low rates is the track record of government. Cutting deals is no forte of civil servants or politicians. The House of Commons Committee of Public Accounts complained that ‘deals look better value for the private sector than for the taxpayer’. As the Committee appealed to the Treasury and other government departments to find better ways to negotiate deals, none of its members was seen to be holding their breath.
A third reason for doubting this modern widow’s curse is that, when state projects make use of scarce resources, the cost of those resources rises, which inhibits private entrepreneurship. No matter how low the interest rate, investment projects should be weighed against competing alternatives Though market-financed private projects might be slower in gestation, prospects for an enduring return are more carefully calculated when it is entrepreneurs who have their ‘skin in the action’.
Such counter-arguments are not new. Writing from the experience of the Great Depression and in opposition to the supposed panaceas that were expounded by Lord Keynes in 1936, the Chicago economist Henry Simons was adamant that
“Adequate reflationary deficits could be obtained without tossing money recklessly in all directions, without reliance on the hurried schemes of bureaucrats, without the numerous disadvantages of “emergency public works,” and without the awful prospect of fiscal reflation carried far beyond the time when it should be reversed”.
Over a hundred years earlier, David Ricardo had produced a simple theoretical argument why there is nothing to be gained if a government funds its spending by borrowing: borrowing merely defers taxation. Ricardo invoked an illustrative loan of £20 million to meet government wartime expenditure. If a tax is levied, taxpayers have the option either of paying £20 million from their current wealth or paying by obtaining private loans of that same value. Whether borrowing is piecemeal by individuals or raised directly by government, the borrowing cost is the annual rate of interest (r) multiplied by the capital sum (£20 million). For a loan in perpetuity, the capitalised value of the annuity is also £20 million (i.e., the amount that might have been raised through taxation). ‘Ricardian equivalence’ is thereby established.
More succinctly and in the argot of more recent times, ‘there is no such thing as a free lunch’.