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Demand doesn’t create its own supply – a national investment bank is needed

investment, pic by 123rf.comThe second [pillar of my leadership] is a new economy that puts public investment front and centre stage: in science, technology and the green industries of the future. Instead of Osborne’s economic house built on sand, our focus will be on the reindustrialisation of Britain for the digital age, driven by a national investment bank as a motor of modernisation – and sustainable growth that will slash the welfare bill in the process”

So says Jeremy Corbyn writing in the Guardian. The economic policies of John McDonnell and Jeremy Corbyn are blowing away some of the accumulated cobwebs of British post-World War II economic policy. Almost literally, they are a breath of fresh air.

There is an old and rightly discredited idea in economics known as Say’s Law, that in effect supply creates its own demand. It is evidently false, because if it were true it would mean that there were never any gluts of products, and never any unsold inventories of stock.

As Adam Smith demonstrated, we do not live primarily in a barter economy; goods are exchanged for a monetary equivalent which then allows the seller to purchase goods. As a result, the producer must first sell his commodity before s/he can purchase. A failure to sell means an inability to purchase. But it took Marx to point out that capitalists may sell a commodity without any intention of purchasing, because they simply intend to accumulate capital which can be used to pay interest or debt, or it may be consumed, may be put into circulation as new products or may be hoarded as capital. For a capitalist enterprise realisation of profit through the sale is the aim, not the subsequent purchase of another product, although in time of crisis even this sale may not be possible.

Yet there is a modern and widely-held inversion of Say’s Law even among progressives, which effectively argues that all that is needed in the current investment-driven crisis is to increase ‘demand’ (by which is generally meant consumption) and supply and investment will follow. While reversing Say’s Law this notion reproduces its fundamental errors. It rests on the assumption that the economy tends towards equilibrium; all that is needed is the occasional stimulus to demand. As a result, it has no explanation for the crisis itself, other than irrationality (of businesses, or of policy makers, sometimes supplemented by greedy bankers). It entirely ignores the role that profit has in determining business ‘purchases’, that is investment. As a result, it cannot explain why demand or consumption may rise, but investment can still stagnate or even fall.

This is important because it describes the current situation. Consumption has risen since the crisis, but investment has not. Fig.1 below shows the level of real GDP in the OECD as a whole since before the crisis to 2014. Real consumption (final consumption expenditure) and real investment (Gross Fixed Capital Formation) are also shown on the same basis. The data are presented in the OECD’s constant prices and constant PPPs (Purchasing Power Parity terms).

Fig.1 OECD Real GDP, Consumption & Investment, US$ PPP terms, 2007 to 2014


In the OECD as a whole GDP has risen by US$2,663bn from 2007 to 2014. Over the same period consumption has risen by US$2,320bn. But investment has fallen by $284bn at the same time.

The largest economy in the OECD and the economy held up as the model for growth is the US. It has grown more strongly than many other large economies in the OECD area in the recent period. But the same pattern is evident. This is shown in Fig.2 below.

Fig.2 US Real GDP, Consumption & Investment, US$mn PPPs 2007 to 2014

In the US real GDP has risen by US$1,102bn over the period 2007 to 2014. Of this US$839bn is the rise in consumption but investment has fallen by US$56bn at the same time. For reference, the same data is show for the UK economy in Fig.3 below.

Fig.3 UK Real GDP, Consumption & Investment 2007 to 2014
 These results are tabulated below, along with the same data for the Eurozone and the Japanese economy.
Table 1. Change in Real GDP, Consumption & Investment for OECD and selected countries,
2007 to 2014, US$ PPPs

With the exception of the Eurozone, GDP has risen in all cases and has risen in the OECD as a whole. But even in the Eurozone, consumption has risen. Yet in no case had this led to an increase in investment over the time period.

This will not remain the case forever. At a certain point investment will recover its previous level before the crisis. In most cases investment is already somewhat above its crisis low-point. But consumption is everywhere above its pre-crisis level and has not produced a recovery in investment. In consequence, in every case the proportion of GDP directed to Invested has declined. As SEB has previously shown, a high or rising proportion of Investment is necessary for high or accelerating levels of GDP growth. As investment in the OECD and its component economies is low and declining, the rate of GDP growth will in general continue to decelerate.

It cannot be argued that consumption has not recovered. Yet investment has not recovered. Policies aimed at increasing ‘demand’, by which is meant increasing consumption, will not by themselves lead to increased investment, as 7 years of crisis in the OECD demonstrates.

To increase investment, it is necessary for the state to increase it as the private sector has shown it cannot or will not do so in the current circumstances. A key component of that will be a National Investment Bank (NIB), and the Labour leadership is right to focus on this. A NIB will allow the public sector to direct investment and to a certain degree to determine its scope. It will so allow the public sector to reap the rewards of the investment it is funding and thereby allow for both improving government finances and further increases in investment. Osborne had a completely phoney Green Investment Bank which was starved of funds. Labour will have a genuine one to raise the level of investment, and therefore growth and living standards.

Relying on increased consumption to produce a rise in investment has been tried and failed. This is because demand does not create its own supply. Increased public investment is required and a National Investment Bank is a key mechanism for that.

This article first appeared at Socialist Economic Bulletin

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  1. David Ellis says:

    As a viable mode of production capitalism is dead. For the first time in history its violent spasms are not simply setting it up for a new golden age or surge. Creative destruction as they call it. Not this time. Capitalism has been a relative fetter on human development since about the 1850s but now it is an absolute fetter. In 2008 it added complete and utter financial bankruptcy to crippling stagnation following the collapse of a thirty year credit bubble turned Ponzi Scam of unfathomable scale. Beyond US-sponsored globalization it could not go and now we see the process of globalization unraveling at a truly alarming rate. The violence of this unraveling process will be ten times the violence that got us here in the first place and will lead inexorably to a New Dark Ages from which we will never escape and which will see human society disintegrate and disappear. But let’s not be too pessimistic because as Marx noted, whilst capitalism is historically contingent and must therefore die no mode of production disappears from history until it has completely exhausted its potential. Capitalism has in the past been able to find away around the mission placed by history on the shoulders of the international working class. It has been able to find the resources to split, bribe, contain, cajole, destroy and thwart its historical grave diggers. Not this time. Capitalism is dead. Austerity and stimulus have the identical effect of exaggerating over-production and driving the crisis ever onward and ever deeper. Stimulus is like injecting a corpse with steroids whilst austerity is merely the embalming of the rotting cadaver. Only one thing can transcend capitalist globalisation and launch human kind on the next leg of its journey: world proletarian revolution. Workers of all countries unite. You have nothing to lose but your chains.

    1. J.P. Craig-Weston says:

      Apart from a few relatively minor details; such as American foreign and economic policy over the last 200 years or so, which can be described usefully and succinctly as simply economic colonialism we’re pretty much on the same page here, once again.

      I’m personally of the view that as has already happened in the all other counties, (throughout South America, the Caribbean and now again in Europe; Greece, etc,) that have had their economies similarly constrained and their politics controlled by international agreements like TTIP and TAFTA, the UK will no longer be allowed to operate any kind of production economy at all and must increasingly now depend the kind of typical low wage service economy, (exploitation is always a useful term for this,) to purchase all our goods and services from, well take a wild stab in the darker here; guess who?

  2. David Ellis says:

    The only worthy socialist programmatic demand in relation to finance is that the bail out of the bankrupt banks be ended. That their staff, estates and deposits be taken into administration to form a new People’s Bank that can lend at base rate to small business and facilitate social investment in accordance with a democratic plan. This bank to have an absolute monopoly on credit so that a private finance sector cannot manufacture its own money or, in the form of bonds, its own counterfeit claims on the social wealth and rip off the nation, the state and the people ever again. Finance must serve the economy and the people not a self-serving elite.

  3. swatantra says:

    Indeed, we need a National Investment Bank. We could also do with a Peoples Bank as well, particularly for those who find it difficult to open an account with the High Street Banks.

  4. Mervyn Hyde (@mjh0421) says:

    Whilst the private banking system exists they can never be trusted, they will in my view always print money whether legislated against or not.

    For the longer term it is my view that we need to take control of the banking system and print money into the economy as and where it is needed, money will be created out of thin air and taxed out of existence as it becomes necessary.

    Tax and interest rates are the regulators of the economy not the providers of finance for public services.

    We can still lend money but it must be regulated
    to control inflation etc.

    Demand should be based on needs not artificial market theory, the private sector should not be subsidised by the state as they operate on the periphery of the economy, the essential heights of the economy should be taken into public ownership as they are fundamentally too important to be left to the whims of private profiteers. The drug companies are the best example of this.

  5. J.P. Craig-Weston says:

    Meanwhile our right wing local MP, for Oldham and Saddleworth continues to bring the message of socialism to people of Oldham:

    Dear all,

    Oldham Fairness Commission, Friday 29th January, 10:00 – 12:30 at Madhlo, Egerton St, Oldham, OL1 3SE

    I am delighted the Oldham Fairness Commission (OFC) will host its conference at Mahdlo at 10am on 29th January, which will be open to the public. At the conference, local Commissioners will commit to the OFC recommendations and discuss their draft actions plans to tackle inequalities and build a fairer Oldham. As everyone is welcome, you too can get involved and join in the discussions to build a fairer Oldham.

    I established the OFC in 2013 in response to the persistent inequalities that exist across Oldham borough.

    The Commission is composed of local individuals, (more, “partners,” well connected scroungers and other sticky fingered parasites mulching of the council funded gravy train,) with proven knowledge and expertise from the public, private and voluntary sectors across the Borough.

    Has anyone here ever heard such a complete load of twaddle; this woman who is my MP is not living on the same planet that I am and would along with most her right on, (Common Purpose ?) mates would probably be far more comfortable living in Germany, in the 1930’s.

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