The case for a National Investment Bank

One of the policy proposals put forward in the leaked Labour Party manifesto last week was the establishment of a National Investment Bank (NIB) to facilitate £250bn of spending on infrastructure over the next ten years. There was no detail in the document about how this might be set up, but there is some merit to the idea if done properly and in this post I offer a look at how it might work.

It is important to be clear at the outset what it should not be. It should not be a conduit for monetary creation by the Bank of England – the so-called People’s QE plan proposed by Jeremy Corbyn when he took over as Labour leader in 2015. PQE essentially requires the central bank to buy the bonds necessary to capitalise such an institution. But this policy is fraught with danger primarily because it erodes the boundaries between government and central bank to an unacceptable degree. In the form envisaged, it allows government to force the central bank to create money to finance whatever projects it deems fit. Moreover, a policy which requires monetary creation on such a scale would also have potential inflationary consequences and no central banker worth their salt is ever likely to endorse such a plan.

That said, there is no reason why a NIB should not work. The UK has tried it before and it was remarkably successful though perhaps not in the way initially envisaged. The Industrial and Commercial Finance Corporation (ICFC) was set up in 1945 by the Bank of England with funding from major commercial lenders to provide capital to small and medium-sized companies. In order to free itself from the constraints of relying on the clearing banks for funds, the ICFC began to tap the market to raise capital. This had an adverse side effect in as much as it raised pressure to generate greater returns on equity, which in turn led to a shift away from longer term, less attractive returns which its core mission delivered, to shorter term higher return projects, which caused problems during times of economic downturn. But by the 1980s it had shifted focus to become a leading provider of finance for management buyouts and had expanded internationally. It became a public limited company in 1987, when the banks sold their stakes, and it was fully privatised in 1994.

Currently, the UK is the only G7 economy not to have an institution which provides finance to the SME sector. In Germany, the Kreditanstalt für Wiederaufbau (KfW) has supported industry since 1948 and in the US, the Small Business Administration (SBA) has operated since 1953. Admittedly, the UK government did dip its toes into the water recently when it established the Green Investment Bank (GIB) in 2012. But despite apparently being successful, it was sold to Macquarie Bank last month for a price (£2.3bn) less than the initial £3.8bn of capital injected by the government.

In an excellent paper commissioned for the Labour Party in 2011, the lawyer Nick Tott outlined the case for a NIB.  But just to show that the case was not party political, former MPC member Adam Posen made a similarly excellent case in a 2011 speech which suggested that not only was there a case for a NIB, but that there was a need for an “entity to bundle and securitize loans made to SMEs … to create a more liquid and deep market for illiquid securities.” The biggest question remains how to capitalise such an institution. The government could commit up to £5bn as initial seed capital – after all it put almost £4bn into the GIB – and it could issue another (say) £5bn of bonds backed by Treasury guarantee. In future years it could divert part of the income generated by National Savings and Investments (NS&I) which raised £11.3bn for the Exchequer in 2015-16 and has assets of £120bn.

Admittedly, this is pretty small scale stuff and would be in no way able to fund the £25bn per annum of infrastructure which the Labour Party is calling for. This is probably a good argument in favour of limiting the remit of such an institution to SME lending rather than big public infrastructure projects. That, after all, is what such institutions do in other countries. Moreover, as Tott points out, it “would need a wide measure of independence from government.” It cannot simply be an arm of government to finance all sorts of pet projects, otherwise those who brand it a return to 1970s-style profligacy will likely be proved right.

A NIB would have to be run along commercial lines. As Posen pointed out, “The existing banks will scream about the unfair cost of capital advantage such an institution would have, but ... since the major banks in the UK have benefitted from a too-big-to-fail situation, any disadvantage they have in funding conditions is offset by the funding advantage they have over smaller or newer financial institutions, which they have gladly accepted. [Admittedly] public sector banks do tend to underperform private banks in credit allocation, and do tend to erode private banks’ profits. Yet most if not all countries have ongoing public lenders of various types (even the US has the SBA), and their existence on a limited scale, while perhaps wasteful at the margin, does not lead to the destruction of the private-sector banking systems in those countries … Let us remember that the UK and other western private-sector banks did that themselves during a period of financial liberalization and privatization unprecedented in postwar economic history.”

There are good reasons why the UK needs to do something to raise investment. For one thing, it is about to lose its EU funding which will put a hole in the transfers to many of the English regions (places like Hartlepool, which were very much pro-Brexit, have received considerable funding in recent years). A more generic macroeconomic problem is that the rate of business investment growth has been below the rate of depreciation since the great recession. This is not an issue which gets much airplay in the big picture story, and I am not sure of the extent to which it represents a change in business behaviour or whether it is a measurement problem. But it means in effect that the UK capital stock is declining, which may be one explanation behind the slowdown in potential growth in recent years. The UK needs to raise its investment levels. Whether a NIB is the right way to go about it remains to be seen. But it is an idea which should not be dismissed out of hand.