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Is Public Borrowing Justified if for Investment Only?

The case for public sector borrowing for investment, as differentiated from borrowing to fund current expenditure, has been made regularly in the last two decades. The general case, in the UK context at least, probably dates back to the late 90’s in the form of the ‘golden rule’ propagated by the then Labour Chancellor, Gordon Brown. That required a balance between revenue and current expenditure over the cycle. The associated ‘public debt’ rule allowed a limited level of deficit to fund ‘sustainable’ investment, while holding the debt close to 40% of GDP. These rules have been revived recently by the Labour Party and also endorsed, to a greater or lesser extent, by the Liberal Democrats.

The justification for such treatment of borrowing for investment is however seldom made explicit and may rest on little more than the intuitive plausibility of the idea that spending for investment must, somehow, be different from current spending. A justification may after all be found in the conventional wisdom of the private economy. Major investment projects are not normally expected to be funded from current revenue, even when that may be possible. Yet borrowing for investment may have the additional characteristic of paying for itself through more economic growth. That aspect may rest on some intuitive version of the ‘multiplier’, another bit of conventional wisdom. That is the effect of government expenditure generating higher incomes and hence more tax revenues, so as to offset the cost of the investment and possibly even reduce the deficit.

The idea has received renewed interest in the current election campaign and in the context of the ongoing deficit/debt reduction debate. Indicatively, the views of the main political parties in this regard were juxtaposed at a radio interview with David Gauke and Chris Leslie as spokesmen for the Conservatives and Labour respectively.[1] For the Liberal Democrats Vince Cable has recently criticised the ‘archaic way’ in which the Treasury fails to make sufficient distinction between growth enhancing capital investment and other public spending.[2] A degree of belief in the self-financing properties of investment spending is probably shared by all those who view austerity-induced low growth or recession as a more urgent issue than the debt/deficit, if not the cause of limited progress towards debt/deficit reduction.

This paper argues that a) public spending for investment is no different from current, as regards its multiplier properties and that b) any increase in public spending can only be partially self-financing, depending on the size of the multiplier. The discussion points to the need to target the budget as a whole and with full consideration of the balance sheet of public assets and liabilities.

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Nicos Zafiris - Thursday 2nd April 2015