What could be done with £7.5bn?

Alan Johnson yesterday set out plans for taxes on banks & banking which he says will raise £7.5bn by the end of the Parliament, but what should he spend it on?

Alan Johnson yesterday set out plans for taxes on banks and banking which he said would raise £7.5 billion by the end of the Parliament, to reduce the cuts in the capital spending budget. This is a significant contribution to the development of Labour’s economic policy – the 2009 Budget included measures to bring forward capital programmes but this is the first time since then that official policy has focused on investment as part of the answer to the current economic crisis.

It is important because a private sector investment slump is actually the main feature of the crisis. From the peak at the beginning of 2008 GDP has contracted by £64bn in real terms. Investment (gross fixed capital formation) has fallen by £37bn. But that includes increased government investment to offset the recession.

Private sector investment has collapsed by over £44bn, and therefore comprises nearly 70 per cent of the entire contraction in the economy. Only a significant increase in the level of investment can provide the basis for a sustainable recovery over the medium-term.

The British economy continues to slip down international rankings of competitiveness, now 13th overall. It is 33rd in terms of quality of transport infrastructure, 35th in education enrolment, 55th in quality of maths and science education… Britain has worse access to quality port infrastructure than landlocked countries such as Luxembourg and Switzerland.

These are precisely the sectors which have borne the brunt of the investment strike through the economic crisis – and where the shadow chancellor should begin in assessing where to spend his £7.5bn.

The table below shows the impact of £7.5bn spent on each of these sectors. Investment in education is included. A number of international studies have shown that education investment has one of the greatest impacts of all (for example, a study of European Union structural funds shows they had the biggest bang for buck was in Ireland because much of the investment was devoted to education as well as physical infrastructure).


Effect of Investing £7.5bn





Economic impact




Government finances




Sources: Office for National Statistics, UK Treasury: The economic impact is taken from the ONS’s analysis of the multiplier effect (‘Leontief Inverse’) in the Input-Output Tables; the impact on government finances is from Treasury analysis

In all cases there is a very sizeable economic short-term impact arising from the investment. There is also a further long-term impact from investment, not captured by the ONS analysis.
It is also noteworthy that in all cases the impact of increased investment in these areas exceeds the initial outlay of £7.5bn. As the £7.5bn funding comes from banks, it would all be a net boost to government finances. It would also be extremely popular.

But the impact on both the economy and government finances also means that there is no reason to be conservative in adopting this approach, every penny of investment will actually lead to higher growth and a narrower public deficit. Seven-and-a-half billion pounds is just half of one 1 per cent of GDP, while the economy is more than 10 per cent below its trend growth path.

The potential sources of funding investment are plentiful. Restoring taxes for businesses and the wealthy that were cut in the June Budget would yield £12.5bn per year by the end of this Parliament. The government can currently borrow long-term funds at below the inflation rate. Most importantly, the nationalised banks are sitting on huge piles of cash as they hoard assets, vastly more than is required as a prudent cushion against further difficulties. RBS alone could be instructed to invest £75bn in these areas while barely making a dent is its capital ratios.

These banks are still run as if they are in the private sector and are participating in, even leading, its investment strike. The private sector is unwilling to increase its investment levels in the current climate. Government spending creates jobs, incomes and profits in the private sector. Cutting it will increase the deterrent to invest.

The idea of using £7.5bn in unused bank resources to increase investment is a good one. But it needs to go much further to revive the economy and close the deficit.

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