Green investments can overcome the paradox of thrift

We need real public investment in Green projects now

Few economists will be entirely surprised that the UK is officially back in recession. We are witnessing a classic case of the "paradox of thrift" in which households, businesses, banks and now government are all retrenching simultaneously, cutting investment, shedding labour, restricting credit and storing money.

Government policies have failed to unlock record levels of private sector savings which could revitalise the stagnant economy. Yet if the Prime Minister and his Cabinet colleagues offer a bold strategic vision which restores confidence in the direction and consistency of public policy on the green economy, there will be golden opportunities for investment which could jump-start growth.

Investment has slumped mainly because households, businesses and banks are nervous about future demand, and have responded by forgoing more risky investment in physical capital, such as infrastructure. Instead, companies are squirreling away private saving into "risk-free" assets such as solvent sovereign bonds. As a result, annual private sector surpluses over the past few years have been at record levels, and amounted to £99bn last year, equivalent to 6 per cent of UK GDP.

Desired saving has exceeded desired investment to such a degree that global real "risk-free" interest rates for the next 20 years have been pushed to zero and below. Savings are losing value by the day as pension funds and financial institutions pay real interest to (rather than receive interest from) governments; a truly perverse state of affairs given the need for productive investment. These low rates do not reflect a collapse in the underlying returns to capital, but instead reflect desperately depleted confidence.

And when everyone retrenches simultaneously, fear of recession becomes a self-fulfilling prophecy, sustaining a vicious circle of low demand and low investment that affects the whole economy.

The UK, like many advanced economies, needs to stimulate economic growth to reduce deficits and debt, but growth requires investment, and investment levels have slumped to record lows relative to output. The longer recovery is delayed and capital sits idle, the more skills are lost and the higher the misallocation of resources, making it harder to restore growth.

Fiscal policy is generally constrained by the need to restore confidence in the sustainability of public debt and, with short-term interest rates close to zero, the effectiveness of monetary policy to stimulate growth is reaching its limits.

What is needed to restore confidence is a clear strategic vision with supporting policies to guide investors. A vision to build an innovative, resource-efficient market economy which restores energy security, tackles climate change, and saves consumers and businesses costs in the long run.

Standard macroeconomics tells us that the best time to support low-carbon investment is during a protracted economic slowdown. Resource costs are low and the potential to crowd out alternative investment and employment is small. In addition, although public budgets are stretched, there is no shortage either of private capital available for investment, or of investment opportunities with potential for profitable returns. The current opportunity should not be missed.

This is about more than correcting market failures, such as those associated with greenhouse gas emissions; it is about restoring confidence through mission-driven investment which spurs innovation in a way comparable to, but bigger in scale than, the space race or the struggle to defeat cancer. Policies to encourage low-carbon investment would provide new business opportunities, generate income for investors and would have credibility in the long term because they address growing global resource challenges, while tapping into a fast-growing global market for resource-efficient activities.

The most recent figures published by the Department for Business, Innovation and Skills show that the UK low-carbon and environmental goods and services sector had sales of £122.2bn in 2010-11, growing 4.7 per cent from the previous year and placing us sixth in the global league table.

But the private sector is not investing as heavily as it could in green innovation and infrastructure because of a lack of confidence in future returns in this policy-driven sector. The Government should incentivise such investment by itself taking on elements of this policy risk which it "controls". By backing its own low-carbon policies, the Government can stimulate additional net private sector investment, and thereby make a significant contribution to economic growth and employment.

The Government can do this, for instance, by allowing the Green Investment Bank to operate as a lending institution, offering loans to private companies so that it shares some of the risk of private investments in green infrastructure.

But it also needs the Prime Minister and his Cabinet colleagues to be publicly supportive of the green economy. Whenever the Chancellor conveys the false impression that we have to make a choice between environmental responsibility and economic growth, he undermines the confidence of private sector investments. The Prime Minister helped to repair some of his damage with a speech this week that highlighted the importance of clean energy, but there needs to be a clear vision for "the greenest government ever".

In past global recessions, rearmament, electrification and space races have helped restore investor confidence – this time the vision should be green. The green sector is one of the few vibrant parts of our economy at the moment. It offers a golden chance to generate growth, as long as the Government makes stronger efforts to restore private sector confidence in public policy.

Savings and investment: A bank vault in the US. Photograph: Getty Images

Dimitri Zenghelis was formerly Head of Economic Forecasting at HM Treasury and is currently a senior visiting fellow at the Grantham Research Institute on Climate Change and the Environment at London School of Economics and an adviser to Cisco systems. His paper, A strategy for restoring confidence and economic growth through green investment and innovation is available at

Show Hide image

Q&A: What are tax credits and how do they work?

All you need to know about the government's plan to cut tax credits.

What are tax credits?

Tax credits are payments made regularly by the state into bank accounts to support families with children, or those who are in low-paid jobs. There are two types of tax credit: the working tax credit and the child tax credit.

What are they for?

To redistribute income to those less able to get by, or to provide for their children, on what they earn.

Are they similar to tax relief?

No. They don’t have much to do with tax. They’re more of a welfare thing. You don’t need to be a taxpayer to receive tax credits. It’s just that, unlike other benefits, they are based on the tax year and paid via the tax office.

Who is eligible?

Anyone aged over 16 (for child tax credits) and over 25 (for working tax credits) who normally lives in the UK can apply for them, depending on their income, the hours they work, whether they have a disability, and whether they pay for childcare.

What are their circumstances?

The more you earn, the less you are likely to receive. Single claimants must work at least 16 hours a week. Let’s take a full-time worker: if you work at least 30 hours a week, you are generally eligible for working tax credits if you earn less than £13,253 a year (if you’re single and don’t have children), or less than £18,023 (jointly as part of a couple without children but working at least 30 hours a week).

And for families?

A family with children and an income below about £32,200 can claim child tax credit. It used to be that the more children you have, the more you are eligible to receive – but George Osborne in his most recent Budget has limited child tax credit to two children.

How much money do you receive?

Again, this depends on your circumstances. The basic payment for a single claimant, or a joint claim by a couple, of working tax credits is £1,940 for the tax year. You can then receive extra, depending on your circumstances. For example, single parents can receive up to an additional £2,010, on top of the basic £1,940 payment; people who work more than 30 hours a week can receive up to an extra £810; and disabled workers up to £2,970. The average award of tax credit is £6,340 per year. Child tax credit claimants get £545 per year as a flat payment, plus £2,780 per child.

How many people claim tax credits?

About 4.5m people – the vast majority of these people (around 4m) have children.

How much does it cost the taxpayer?

The estimation is that they will cost the government £30bn in April 2015/16. That’s around 14 per cent of the £220bn welfare budget, which the Tories have pledged to cut by £12bn.

Who introduced this system?

New Labour. Gordon Brown, when he was Chancellor, developed tax credits in his first term. The system as we know it was established in April 2003.

Why did they do this?

To lift working people out of poverty, and to remove the disincentives to work believed to have been inculcated by welfare. The tax credit system made it more attractive for people depending on benefits to work, and gave those in low-paid jobs a helping hand.

Did it work?

Yes. Tax credits’ biggest achievement was lifting a record number of children out of poverty since the war. The proportion of children living below the poverty line fell from 35 per cent in 1998/9 to 19 per cent in 2012/13.

So what’s the problem?

Well, it’s a bit of a weird system in that it lets companies pay wages that are too low to live on without the state supplementing them. Many also criticise tax credits for allowing the minimum wage – also brought in by New Labour – to stagnate (ie. not keep up with the rate of inflation). David Cameron has called the system of taxing low earners and then handing them some money back via tax credits a “ridiculous merry-go-round”.

Then it’s a good thing to scrap them?

It would be fine if all those low earners and families struggling to get by would be given support in place of tax credits – a living wage, for example.

And that’s why the Tories are introducing a living wage...

That’s what they call it. But it’s not. The Chancellor announced in his most recent Budget a new minimum wage of £7.20 an hour for over-25s, rising to £9 by 2020. He called this the “national living wage” – it’s not, because the current living wage (which is calculated by the Living Wage Foundation, and currently non-compulsory) is already £9.15 in London and £7.85 in the rest of the country.

Will people be better off?

No. Quite the reverse. The IFS has said this slightly higher national minimum wage will not compensate working families who will be subjected to tax credit cuts; it is arithmetically impossible. The IFS director, Paul Johnson, commented: “Unequivocally, tax credit recipients in work will be made worse off by the measures in the Budget on average.” It has been calculated that 3.2m low-paid workers will have their pay packets cut by an average of £1,350 a year.

Could the government change its policy to avoid this?

The Prime Minister and his frontbenchers have been pretty stubborn about pushing on with the plan. In spite of criticism from all angles – the IFS, campaigners, Labour, The Sun – Cameron has ruled out a review of the policy in the Autumn Statement, which is on 25 November. But there is an alternative. The chair of parliament’s Work & Pensions Select Committee and Labour MP Frank Field has proposed what he calls a “cost neutral” tweak to the tax credit cuts.

How would this alternative work?

Currently, if your income is less than £6,420, you will receive the maximum amount of tax credits. That threshold is called the gross income threshold. Field wants to introduce a second gross income threshold of £13,100 (what you earn if you work 35 hours a week on minimum wage). Those earning a salary between those two thresholds would have their tax credits reduced at a slower rate on whatever they earn above £6,420 up to £13,100. The percentage of what you earn above the basic threshold that is deducted from your tax credits is called the taper rate, and it is currently at 41 per cent. In contrast to this plan, the Tories want to halve the income threshold to £3,850 a year and increase the taper rate to 48 per cent once you hit that threshold, which basically means you lose more tax credits, faster, the more you earn.

When will the tax credit cuts come in?

They will be imposed from April next year, barring a u-turn.

Anoosh Chakelian is deputy web editor at the New Statesman.