investment

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Productivity stinker

Published by Anonymous (not verified) on Wed, 10/08/2022 - 6:38am in

In yesterday’s post about chronically low levels of investment, I concluded that they’ve “given us stagnant productivity growth and a collapsing infrastructure.” This morning, the Bureau of Labor Statistics (BLS) confirmed the productivity part. For the year ending in the second quarter, it was down 2.5%, the worst in the series’ 75-year history. 

Productivity sounds like one of those things only the orthodox worry about, but it doesn’t have to be. Its most common form, labor productivity, is a measure of how much a worker can produce in an hour on the job. While that sounds conceptually simple, measuring output is no simple task; few of us are producing “widgets,” that discrete, standardized, and mythical commodity beloved of the homilies in economics textbooks. The standard way of measuring output is its “real” (inflation-adjusted) dollar value (or whatever your national currency is). That may seem like a bit of a kludge, but that’s capitalism for you—it is all ultimately about monetary values.

Output is one thing; how the proceeds of that output are divided are entirely another. Some go to wages, some go to the boss, some go to the shareholders. Over the last couple of decades, the share going to the worker has declined, from about 65% of value-added in the 1960s to around 60% today. But however those proceeds are divided, their growth puts an upper limit on the growth in incomes and with them, material well-being.

Here’s a graph of the history of productivity growth for all nonfarm businesses in the US. Since the quarter-to-quarter numbers can be very volatile, I’ve added a trendline (of the Hodrick-Prescott variety—it’s been criticized as imperfect but what isn’t in this fallen world?).

Productivity yty

It looks awful, though the downdraft in the trendline may be partly exaggerated by the record-low reading for the most recent quarter. But if that trendline is approximately right, then the current situation is echoing that of the 1970s, a time of falling real wages and rising inflation. (Sound familiar?) 

Real wage growth has been terrible lately. According to the measure published in the monthly employment reports, which excludes fringe benefits, the hourly wage has lost over 5% of its value since December 2020. The compensation measure reported along with these productivity members includes fringes, and has lost about half that much over the same period. In any case, it’s striking that in what is by most measures the tightest labor market in decades, a situation that is suppose to enhance labor’s bargaining power with capital, we’re seeing real wage declines. To put that in perspective, here’s a full history of this compensation measure. It looks awful too.

Real compensation

The spike in 2020 is the result not of pandemic-induced wage increases, but the job losses, both temporary and permanent, experienced by low-wage workers in food service and retail in the early lockdown phase. That drove up the average wage. As that was reversed, the average was dragged down. Those disruptions are now largely complete and the measure is back to reflecting reality (as well as any average can).

But a lot of this wage story, especially recently, is driven by inflation. Here’s a history of nominal (not adjusted for inflation) hourly compensation. Like the 1970s, the strong nominal wage gains of the last couple of years have been entirely eaten up by inflation.

Nominal compensation

As a result of strong nominal wage gains and weak productivity growth, unit labor costs—the wage costs of producing a unit of output—have been rising. Again, the only precedent for recent experience is the high-inflation years of the 1970s.

ULC

Rising unit labor costs are generally a prescription for sustained inflation. And the idea, common in some precincts of the left, that inflation is a concern mainly of the rich has no basis in fact. Rich people have been doing fine of late, while middle- and lower-income households are struggling to pay for basics.

But instead of blaming greedy workers for the inflation, as a reactionary might, I want to blame low levels of investment. For evidence, look at what happened in the late 1990s. The graphs in yesterday’s investment post show a rise in net investment in the 1990s—from 1992 to 2000, to be precise. These graphs show a sustained acceleration in both productivity and real wage growth over roughly that period—and no rise in unit labor costs. But it was the byproduct of the dot.com bubble, when for a brief time Wall Street welcomed high levels of real investment. When the bubble burst, so did financiers’ interest in boosting capital spending.

Perhaps these are just pandemic disruptions that will peter out over time. But it does seem like the management of Corporate America, and especially its shareholders, have embraced the low-investment, low-productivity model. And the payoff from that is riches for them and high inflation and declining real wages for the rest. Standard austerity programs—fiscal and monetary tightening leading to recession and unemployment—won’t address the underlying problem. An austerity program could lower inflation, but it’s not going to bring about mass prosperity. For that we need higher investment of a sort the system seems incapable of producing.

 

Washington will pick up the check

Published by Anonymous (not verified) on Tue, 09/08/2022 - 8:38am in

Semiconductor firms are about to get showered with cash thanks to a new bill, The CHIPS and Science Act of 2022—CHIPS standing for, cleverly, The CREATING HELPFUL INCENTIVES TO PRODUCE SEMICONDUCTORS Act. Because it involved free money for capitalists, 17 Republicans (out of 50) voted for it despite their habit of voting against almost anything supported by Democrats except money for the Pentagon. Biden is scheduled to sign it on Tuesday, August 9.

It’s a $280 billion package designed to encourage semiconductor manufacturing and research in the US. Pundits and generals have watched with increasing alarm as chipmaking moved from an industry dominated by the US and to a lesser extent Western Europe to a heavily Asian affair, meaning Taiwan, South Korea, and China (the big threat lurking behind all the worry, of course). The covid crisis highlighted how dependent US and European producers—carmakers, computer companies, appliance manufacturers—have become on Asian chipmakers.

The CHIPS Act is supposed to address all that, bringing the industry back home and restoring the Silicon Valley to its rightful place of global dominance. But that’s not all. When she wasn’t stoking war with China (which would require plenty of advanced chips, presumably sourced from countries other than China), Nancy Pelosi took time out to say that the CHIPS Act would create “nearly 100,000 good-paying, union jobs.” One is skeptical.

provisions

Among its provisions is $53 billion in subsidies to the US chip industry to encourage domestic R&D. Of that, $39 billion is a direct subsidy, and the rest is for “workforce development” and speeding up the “lab to fab” pipeline. The bill also includes large tax writeoffs for companies that expand chip facilities in the US, which would theoretically close the cost gap between building here and abroad. Aid won’t be confined to American firms; industry leader Taiwan Semiconductor Manufacturing Co. (TMSC) will be eligible as long as they do the work here.

The Biden administration is touting a plant Intel is building in Ohio—he even devoted 147 words to it in his State of the Union address—as proof of the CHIPS Act’s powers, but Intel has been playing politics with the project. In June, impatient with Congressional dithering on the bill, it canceled a formal groundbreaking ceremony, emphasizing that it’s building plants in countries that have gotten their subsidy act together. (Mercifully, the EU has its own Chips Act.) Intel also said its long-term plans for the site would depend on the continuing flow of free federal cash. (TSMC said its investment plans also depended on adoption of the bill.) On its passage, ​Intel CEO Pat Gelsinger said, “I’m excited to put shovels in the ground as Intel moves full speed ahead to start building in Ohio,” though I suspect Gelsinger himself won’t be operating any shovels. Intel may be happy, but just last month some smaller firms were complaining that it and the other giants would get all the money and they’d be frozen out.

About $200 billion will be also devoted to basic research in computing, robotics, and semiconductors through the National Science Foundation and other federal agencies. Universities getting grants under the program would be prohibiting from participating in educational partnerships with the Chinese government known as Confucius Institutes. These have been under relentless attack for nearly a decade, as the anti-China campaign ramped up.

Worries have been raised about the return of “industrial policy,” pronounced dead in the 1980s (though the Reagan administration did craft a giant aid package for the chip industry known as SEMATECH). Rather than the return of industrial policy, what’s actually distressing is watching public money go into private coffers with so little coming in return.

The CHIPS Act bars its beneficiaries from using the money to do stock buybacks or pay dividends, though it’s not clear how one set of a few billion dollars can be distinguished from another. It would also deny money to firms expanding in China and other countries deemed unfriendly. Economic warfare is ramping up.

billions in buybacks

Criticism of the bill from the left has largely focused on the quickness of US firms to expand abroad. Bernie Sanders said, “Any company who is prepared to go abroad, who has ignored the needs of the American people, will then say to the Congress, ‘Hey, if you want us to stay here, you better give us a handout.’”

He is right, though that is pretty standard practice in American capitalism. His colleague Sherrod Brown, who might have been relied on for a denunciation, likes the bill because of the Intel plant in his state, Ohio. And few Congresspeople could turn down cash for universities in their states and districts.

It was probably an oversight, but Sanders could also have pointed out how much the likely recipients have already spent on stock buybacks. It’s a small fortune. 

Between 2010 and 2021, ten top semiconductor firms spent $168 billion buying their own stock.* Here’s a graph of the running total of buybacks for those ten firms, and Intel, the biggest chip firm. It alone spent $86 billion over the same period. Both sums vastly exceed the $39 billion the gov is showering on the industry in direct subsidies.

Stock buybacks, chip firms, cume

As this graph shows, there was a burst of buyback activity in 2018 and 2019. Probably not coincidentally, 2017 was the year when Trump’s corporate tax cuts took effect. In theory, those were supposed to contribute to a burst of investment; they didn’t. Though the buyback pace eased after covid hit, 2021’s total was still higher than all but one year between 2010 and 2017.

Stock buybacks, chip companies

Buybacks do little but boost stock prices, making stockholders happy and fattening CEO paychecks, which are largely based on stock prices. They could have invested the money, but that sort of thing is frowned upon in the higher Wall Street consciousness. Better to “return” the cash to shareholders, as they say, even though they actually provided no cash in the first place. Stockholders just buy their shares from previous stockholders, not the company.

Since Intel is so big, we also looked at its earlier buybacks, starting in 1990. That prehistory adds another $69 billion to the company’s total buying spree, taking the 31-year total up to $152 billion.

As I argue in today’s semi-companion post, the US economy has long been plagued by low and declining levels of net investment, a result of the shareholders-first doctrine of the last four decades. Fortunately for the semiconductor industry, Uncle Sam is effectively picking up the tab for its buyback spree.

* The ten firms are, in declining order of total buybacks, are Intel, Texas Instruments, Applied Materials, Broadcom, Analog Devices, NVIDIA, Micron, KLA, Marvell, and AMD.

America: the rot goes on

Published by Anonymous (not verified) on Tue, 09/08/2022 - 7:17am in

NYC subway rot s

It’s been a while since I looked at one of the major reasons for the pervasive sense of rot about the US: the low level of investment—investment in real things, that is, not crypto. It’s barely keeping up with the forces of decay. If you’re wondering why nothing works and everything seems to be falling apart, here are some explanations.

First a definition: investment is spending by businesses, governments, and individuals on long-lived physical assets like buildings and machinery. Gross investment is the dollar value of such spending; net is what remains after deducting depreciation, aka wear and tear. That’s not an easy process to put a dollar value on, but it’s all we’ve got. And besides, these are numbers the capitalist state produces to understand its economy, so why not take them seriously, even if the bourgeoisie seems unalarmed about them?

Graphed below is the average value of net public and private investment as a percentage of GDP by decade. Civilian public investment means expenditures on long-lived assets like schools and roads, but excluding the military. (To anticipate a question I sometimes get: yes, prisons are in there too, but they don’t count for much; almost all the costs of maintaining the carceral state come from day-to-day operations.) Private investment consists of purchases of buildings, equipment, and intellectual property (IP) by businesses and. Not shown on this first graph: residential investment, the purchase of housing by individuals and improvements to that housing.

Net investment by decade

Averages for the 1930s reflect the extraordinary circumstances of the Great Depression: private investment collapsed and New Deal-driven public investment soared. Those high levels of public investment gave us an infrastructure that we still use today—schools, post offices, and parks. (For a catalog of those projects, check out the Living New Deal.) Public investment sagged during the 1940s, reflecting World War II, but rose in the 1950s and 1960s, matching the 1930s level as the public sector expanded. It was not to last: austerity and privatization consciousness took over, and now net public investment is at a record low.

Private investment rose in the decades after World War II, peaking in the 1970s. But the Wall Street-driven imperatives of profit maximization that got the upper hand via the Shareholder Revolution of the 1980s, which transformed corporate practices, put the squeeze on investment. Investing too large a share of corporate profits in things came to be seen as wasteful—better instead to hand the cash over to the shareholders, via stock buybacks and traditional dividends.

Here’s a yearly view of the trajectory of decline, a path traced by the dotted trendlines. The graphs begin in 1950 because the extremes of the 1930s and 1940s would have distorted the scale.

Net investment, public & private, yearly

These graphs show a relative stability in net private investment from the late 1950s through the early 1980s, when Wall Street’s grip on corporate cash flow tightened. There was a surge in the late 1990s, the period of the New Economy mania and the early commercial internet—an enthusiasm which was at least backed up with investment in the technology that was supposed to bring about the future. We haven’t seen much of that in the latest iteration of tech mania, the era of Uber and Airbnb.

Here’s a look at some components of private investment. The equipment and especially the structures trendlines show a persistent downward path. Against that, IP’s rise stands out—to the point where it’s surpassed investment in buildings and is rivaling equipment. Both equipment and structures used to be several times IP. Capitalists are spending less money on things that are supposed to promote general prosperity and more on legal arrangements that protect theirs.

Net private investment by type

Low levels of net private investment aren’t driven by declines in gross investment, which has been pretty stable. Instead, the major reasons for the decline are a shift towards shorter-lived equipment and the immateriality of intellectual property (IP) and a shift away from buildings. From 1950–1999, net fixed private investment averaged 32% of gross; since 2000, it’s averaged 20%—and 16% since 2020. Every asset category has seen that shift—even buildings.

Intellectual property investment, whose share of business investment grew from 8% in 1950 to 40% today, adds another layer of fleetingness to the story. Business ideologues love to tout IP as a stimulant to innovation; who’d invent anything if they couldn’t patent it? Lots of people would, actually. That aside, most basic innovation in sectors like computing and pharmaceuticals have been funded by public entities, not private companies, who then appropriate those innovations to make profits from research they didn’t pay for. Instead of supporting innovations, a lot of IP investment is about trying to establish monopolies, be it in the latest variation on an antidepressant or a Disney cartoon character. But even here the trend towards shorter-lived assets is visible: net IP investment went from 27% of gross in the 1950s and 1960s to 16% since.

For the public sector, the decline in net investment has been more dramatic, falling from around 2% of GDP in the early decades on the graph to 0.4% since 2020. (It’s 0.3% so far in 2022.) Like the private sector, we’ve seen a shift towards shorter-lived assets, but unlike the private sector, we’ve also seen a decline in gross investment, which fell by almost half between the 1960s and 2020s. Net public investment as a percentage of gross went from 67% in the 1950s and 1960s to 27% in the 2020s. Net federal civilian investment is just 0.1% of GDP so far this decade, a third its 1950–1999 average. State and local investment has fallen harder, down by almost three quarters from that 50-year average to 0.5% in the 2020s (0.3% so far this year).

Net residential investment

And as the graph above shows, residential net investment isn’t doing too great either: it went from an average of 2.8% of GDP from 1950 to 1999 to 1.7% in the 2020s. Unlike the mid-2000s housing bubble, which took net residential investment up to 3.8%, the highest since the early post-World War II years, the latest bubble took net housing investment up to just 1.9% of GDP last year. It’s fallen back to 1.4% in 2022. That’s not the way to meet a housing deficit estimated by Freddie Mac at 3.8 million units.

The burst of net private investment in the late 1990s gave us a major productivity acceleration, but it was not to last. And the burst in civilian public investment from the early 1950s through the late 1960s gave us interstate highways, schools, and state university systems. The long declines in net investment, both private and public, have given us stagnant productivity growth and a collapsing infrastructure.

As I put it when I wrote about net investment five years ago, “If I were a debased purveyor of clickbait, I’d call this “Everything that’s wrong with America in two charts.” But I’m not, so I won’t. But still….”

More true than ever.

Photo is by me, of the 7th Ave stop on the G line of the New York City subway.

Debt and investment: what can we learn from SMEs’ investment behaviour during and after the Global Financial Crisis?

Published by Anonymous (not verified) on Wed, 25/05/2022 - 6:00pm in

Mai Daher and Christiane Kneer

Many UK firms weathered the Covid shock by taking on debt. Small and medium-sized enterprises (SMEs) in particular borrowed at an unprecedented rate and their debt increased by around a quarter since end-2019. But debt that allowed SMEs to survive the pandemic could now hamper the recovery as indebted firms may struggle to invest and grow. Debt on SMEs’ balance sheets could also make firms more vulnerable to future shocks and could amplify downturns if indebted firms reduce investment more following shocks. To understand how investment might evolve, our recent FS paper examines how leverage affected SME investment during and after the Global Financial Crisis (GFC) and discusses potential differences given regulatory and other changes since the GFC.

Debt can help firms bridge liquidity shortfalls and finance productive investment. This allows them to build capital stock faster than relying solely on cash buffers, earnings or equity finance. But it can also make firms vulnerable and lead them to cut investment expenditure by more than firms with less leverage following shocks (see Kalemli-Ozcan et al). Leveraged firms with high debt service burdens may not be able to fund investment during downturns when earnings fall and credit conditions tighten, especially for riskier borrowers. But leveraged firms may not only be more constrained by credit supply. Demand-side factors could also reduce investment by leveraged firms: Firms with more leverage may suffer from ‘debt overhang‘ and be reluctant to invest if the returns on investment accrue to debtors. The debt overhang problem can be aggravated during downturns when returns on investment are lower. Highly indebted firms may also choose to forego investment in order to deleverage and to rebuild their balance sheets when vulnerabilities from indebtedness are exposed.

If we classify SMEs by their leverage at the onset of the GFC in 2006/07 and trace out average investment paths of firms in different leverage buckets over subsequent years, a clear pattern emerges: SMEs with higher initial leverage invested less, not only during the GFC but also during the subsequent recovery period (Chart 1a). Differences in fixed asset growth across firms with different leverage ratios during the crisis itself amplified subsequently, resulting in large gaps in firms’ capital stocks by the end of the period in 2014. Firms with leverage ratios below 20% continued to build their stock of fixed assets and invested more than the amounts needed to replace depreciating capital. By contrast, firms with leverage ratios above 20% saw their stock of fixed assets fall over time, with more leveraged firms investing less on average. Investment patterns were very different during the pre-crisis period: Chart 1b shows that the fixed asset stock of firms grew between 2001 and 2006, irrespective of firms’ initial leverage ratios in 2000/01. Furthermore, there was no clear relationship between SMEs’ initial leverage and the strength of their subsequent investment. This suggests that the relationship between debt and investment changes during and after economic downturns.

Chart 1a: Average investment during and after the GFC by SMEs in different initial leverage buckets

Chart 1b: Average investment before the GFC by SMEs in different initial leverage buckets

Note: Firm balance sheet data are sourced from BvD’s Fame database. The chart shows average cumulative fixed asset growth of SMEs in different leverage buckets Leverage is measured by total liabilities to total assets ahead of the GFC (Chart 1a) or in 2000/01 (Chart 1b). The investment horizons range from 2007–08 up to 2007–14 in Chart 1a and from 2001–02 up to 2001–06 in Chart 1b.

Local projections suggest that SMEs with higher leverage reduce investment more after shocks

We confirm this striking pattern using local projections to estimate how a firm’s investment over different horizons responded to the GFC conditional on its leverage ratio at the onset of the crisis. In our regressions, we control for other factors that could affect investment and could be correlated with leverage including a firm’s size, age, profitability, cash buffers or previous investment.

Chart 2 plots the effect of being more leveraged at the onset of the crisis on investment over different horizons. Investment is captured by fixed asset growth between 2007 and 2014. The results confirm that SMEs with more leverage at the onset of the GFC invested less during the crisis than firms with less leverage. Similar to the evidence by Joseph et al (2021) in their analysis of cash-investment sensitivities, we find that the effect of initial leverage was persistent and increased over time. Our results suggest that an increase in the pre-crisis leverage ratio by 10 percentage points reduced fixed asset growth during the crisis (2007–09) by almost half a percentage point and by 0.7 percentage points between 2007 and 2014.

Chart 2: The effect of a 10 percentage point increase in the initial leverage ratio on fixed asset growth

Note: The solid line depicts the coefficients from regressions of investment over different investment horizons on initial leverage and control variables for a sample of 33,872 SMEs. Investment is measured as cumulative fixed asset growth over 2007–08 up until 2007–14. The chart depicts the effect of a 10 percentage point increase in the initial leverage ratio, captured by total liabilities to total assets in 2006/07.

We also find that this negative relationship was driven by relatively capital-intensive SMEs. For these firms, an increase in the leverage ratio by 10 percentage points was associated with a reduction in fixed asset growth by 0.7 percentage points during the crisis and by 1.6 percentage points between 2007 and 2014. This heightened sensitivity to balance sheet vulnerabilities could be due to the scale, and possibly the lumpiness of the investment expenditure of capital-intensive firms. These firms have to maintain a larger stock of capital and could therefore be more dependent on external sources of finance. Capital-intensive firms make up for the bulk of investment in our sample and their impact on aggregate demand is therefore more significant.

When assessing the effects of different types of leverage on investment, we find that short-term liabilities and short-term bank loans drove the negative relationship between leverage and investment. Firms with short-term debt were exposed to rollover risk and faced the risk that the terms or the availability of credit would deteriorate.

Possible drivers of debt-investment sensitivities

To better understand the underlying drivers of the negative relationship between debt and investment, we also analyze how firms with different leverage ratios adjusted other components of their balance sheets. We find that SMEs with higher pre-crisis leverage subsequently deleveraged more (blue bars in Chart 3) and built up cash buffers and liquid assets (green bars in Chart 3) both during the crisis and the recovery period. Balance sheet repair that accompanied and potentially drove investment cuts by more indebted firms could have been caused by either demand-side or supply-side factors.

Chart 3: The effect of a 10 percentage point increase in the initial leverage ratio on the growth rate of liabilities, debt, current assets and cash holdings

Note: The chart presents results from regressing the change of logged total liabilities, total debt, current assets and cash holdings over different horizons on initial leverage and control variables. Initial leverage is measured as total liabilities to total assets in 2006/07. The chart depicts the effect of a 10 percentage point increase in the initial leverage ratio. The effect of initial leverage is significant at conventional levels of significance in all regressions.

Understanding whether the impact of debt is driven by the inability of firms with high leverage to fund investment (supply side), or whether leveraged firms were less willing to invest (demand side) is important for the design of macroprudential tools to address potential risks from low investment after a shock. Regulatory changes after the GFC that improved bank capitalization, reduce the likelihood of sharp contractions in credit supply following a shock.  But demand-driven underinvestment might instead require borrower-based macroprudential tools targeting corporate borrowers.

While we cannot empirically identify the channels working through demand-side factors, we provide indicative evidence that investment by indebted SMEs during the GFC was constrained by credit supply. We show that deleveraging by firms with higher initial debt was accompanied by increases in the cost of credit for those firms, which is consistent with a reduction in credit supply. Furthermore, we find larger debt-investment sensitivities for SMEs that were customers of banks with weaker balance sheets at the onset of the crisis. Leveraged firms borrowing from banks which had lower liquidity ratios, larger increases in write-offs and higher leverage ratios reduced investment more after the crisis. However, the presence of supply-side effects does not imply that demand-side factors did not also play a role.

Could indebted SMEs slow down the recovery from the Covid shock and amplify future downturns?

Unlike the GFC, the Covid shock was not accompanied by a financial crisis and government loan schemes allowed SMEs to access finance to weather the shock. For the majority of SMEs, it is therefore unlikely that a contraction in credit supply interacted with prior leverage to depress investment since the start of the pandemic. However, if demand-side channels drive debt-investment sensitivities, the additional debt taken on during the pandemic may have contributed to the subdued business investment in the UK since 2020 and could slow down the recovery.

Going forward, both demand and supply-side factors could make indebted SMEs vulnerable to future shocks and lead these firms to cut investment more, amplifying potential downturns. Risks should be mitigated by macroprudential regulation introduced after the GFC which reduces the likelihood of sharp contractions in loan supply. Debt may also constrain investment demand by SMEs less than during the GFC. Much of the additional debt taken on during the pandemic was provided through government loan schemes with low interest rates and long tenure.

Mai Daher and Christiane Kneer work in the Bank’s Macro-Financial Risks Division.

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The dismal decade

Published by Anonymous (not verified) on Tue, 09/03/2021 - 10:05am in

Earlier today, the Governor of the Bank of England, Andrew Bailey, gave a speech at the Resolution Foundation outlining the nature of the Covid-19 crisis and the challenge that it poses for monetary policy. But as his speech progressed, it became clear that the Bank faces a much larger challenge. Covid-19 hit the UK economy at the end of a dismal decade. Returning to "where we were" before the pandemic won't be good enough. 

Just how dismal the 2010s were is evident in this chart from Andrew Sentance: 

Even before Covid-19 struck, average GDP growth was well below its historical average and heading downwards. The 2010s were, to put it bluntly, a decade of stagnation.  The 2000s were slightly worse, but that was because they included the deep recession after the financial crisis, during which the economy shrank by 6%. For the 2010s, there was no such excuse. 
So Covid-19 hit an already under-performing economy. As a result, Sentance's forecast for the 2020s is frankly terrible. Not since the 1920s has economic growth been so low. But of course, this is a forecast. The challenge facing the Bank of England is to ensure that it does not come to pass.   
But why was economic growth in the 2010s so underwhelming? This chart from Bailey's speech shows the behaviour of GDP growth rates in the last two decades: 

There's quite a lot of noise in the figures, particularly prior to the financial crisis, so the Bank of England has helpfully added lines showing average RGDP growth for three key periods: 2000-2007, 2010-2016, and 2017-19. It is evident that the average in each period is lower than in the one before. The growth rate appears to be trending downwards. 

But let's look through those lines and see what the chart itself tells us. Firstly, and obviously, GDP growth was on average stronger before the financial crisis than afterwards. And it was also considerably more volatile. We don't know why, but one factor might be the light regulation of the financial sector at that time. Bank lending is known to be pro-cyclical, so variations in banks' appetite for risk might be expected to cause swings in the GDP growth rate. Since the financial crisis, the financial sector has been much more tightly regulated. This dampens the procyclicality of bank lending, so might reduce the volatility of GDP growth. But does it also dampen the average GDP growth rate? 

Secondly, the post-financial crisis recovery tailed off quickly and GDP growth slumped to less than 1% in 2011-12. Was this solely because of the impact of the Eurozone crisis, or did the front-loaded austerity of the Coalition government play a part? In my view, an under-appreciated factor is the tax increases on energy in 2010-11, which combined with a sharp rise in oil prices to cause energy price rises of 20% or more for households and businesses. 

The economy recovered to a post-crisis high by 2014. But then growth tailed off again. What caused this? And why has the GDP growth rate been pretty much stuck at a measly 1.5% since 2016? 

Much of Bailey's speech is devoted to the economic reasons for this long slump. The political issues understandably didn't get an explicit mention, but they were there under the surface, and the French economist Helene Rey didn't hesitate to spell them out in her response. It is not just the Covid-19 crisis from which the UK economy must recover. And although the financial crisis threw a long shadow, it was not responsible for the GDP growth rate flatlining in 2017-19. That was caused by Brexit. 

It has become taboo to say, or even imply, that the Brexit vote of 2016 was in any way negative for the UK economy. If the Bank of England governor had dared to say openly that the primary reason for four years of stagnation prior to the Covid-19 shock was investment collapse due to Brexit, he would have been accused of making political statements. But it is the truth. 

Here's the evidence from Bailey's speech:


Business investment fell off a cliff at the Brexit vote and never recovered. 
For those who look at this chart and think "yeah right, chart crime" (I agree, btw), here's confirmation that the Brexit vote halted the growth of business investment, courtesty of Andy Bruce at Reuters: 

The final chart in Bailey's speech graphically illustrates just how damaging the Brexit vote was. Bailey describes it thus: 

The effect of this weakness in investment can also be seen by looking at capital services – a measure of the value of the flow of services which are derived from the capital stock, including machinery, equipment, software, structures, and land improvements. This may better capture the drivers of supply growth than looking at growth in investment alone. It shows a sharp decline following the collapse in investment during the global financial crisis, and a subsequent recovery, which flattened off as a result of the weak investment in the period prior to Covid. 

The chart actually shows that the recovery in capital services growth was partially reversed by the Brexit vote. But I guess that is too "political" for the Governor of the Bank of England to say openly.  

Britain left the EU on 31st January 2020, just before the pandemic hit. On 31st December 2020, the transition period during which Britain effectively still remained part of the single market and customs union ended. This coincided with the third and most serious wave of the virus and a strict lockdown. We don't yet have GDP or investment figures for the first quarter of 2021, but it seems likely that the UK is in recession and investment has crashed. The Government seems to want to blame everything on the pandemic, but it's clear that Brexit had caused GDP growth to slow even before it was complete, and the disruption caused by the imposition of regulations from January 2021 is bound to have made matters worse. The recession is therefore probably deeper than it would have been without Brexit, and as Brexit is a permanent change, there will be lasting scarring. 
Inadequate business investment isn't the sole cause of poor GDP growth. Indeed, the Bank of England's chart shows that business investment was noticeably stronger in the post-crisis period up until the Brexit shock than it was before the financial crisis, and yet growth was significantly lower. But during that time, government investment was slashed to zero in a vain attempt to balance the budget: 

Thus, although real business investment increased, total investment fell. This was in addition to the aforementioned tax rises, and the damaging cuts to public spending about which I have written many times. The weakened UK economy lost the fiscal support that would have helped it to recover. Even though government investment picked up somewhat between 2017-19, it was not enough to offset the failure of business investment after the Brexit vote. Ten years of slump can be firmly laid at the door of successive UK governments. 
The story of the dismal decade is one of repeated economic shocks, mostly self-inflicted, which trashed investment and derailed recovery. Now, the combination of the Covid crisis with the Brexit shock, plus the lasting legacy of the misguided austerity imposed on a weakened economy after the financial crisis, threatens to turn the 2020s into the decade from hell. 
But it doesn't have to be like this. The connection between investment and economic recovery is firmly established. And there is no time to wait for private sector confidence to return, particularly as Brexit is already a much longer-lasting shock to business investment than Covid and there is no reason to suppose that things will improve any time soon. When the private sector can't or won't invest, the public sector must do so. We need big government investment, not only to pull the economy out of the Covid recession, but to end a decade-long and wholly unnecessary slump.    
The Governor still seems to think that kickstarting recovery is the Bank of England's responsibility. But the Bank of England doesn't do investment. That's the job of government. Government failed in its duty after the financial crisis. It is imperative that it does not do so again. If we are ever to get out of this dismal swamp, the Bank must step back, and government must turn on the investment taps.
Related reading: 
Happy days are here againAusterity and the rise of populism Low growth is the "New Normal" for the UK and other Western economies - Andrew SentanceGetting over Covid - Andrew Bailey, Bank of England

Image: The Slough of Despond from Pilgrim's Progress by John Bunyan. 

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