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The Road to Recovery: How and Why Economic Policy Must Change by Andrew Smithers

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5

Cyclical or Structural: The Key Issue for Policy

Until there is a change in the way managements are paid, those companies which operate under the current bonus system will continue to prefer the long-term risks of losing market share rather than the short-term ones that would come from allowing margins to narrow and will continue to buy shares in preference to spending money on new equipment. But the combination of high margins and weak capital spending is at the heart of our current economic malaise, as it boosts the intended savings of companies and depresses their intended investment. According to standard economic theory, the correct policy response to an intended surplus of savings over investment is for the government to run a budget deficit. This has the effect of reducing the intended savings of the economy as a whole. When a government spends less than its income, it saves; when it spends more than its income, it has negative savings, i.e. it “dis-saves”. By running a budget (i.e. a fiscal) deficit, the government's negative savings offset the surplus of intended savings over intended investment in the business sector.

After the event the amount of savings in the whole economy has to match the amount spent on investment. If there is a mismatch between intentions to save and to invest, the economy has to adjust. If the intentions to save are greater than those to invest, the adjustment takes the form of a fall in incomes and output, so that the intentions to save are ...

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