The difference between current and capital spending

Capital spending is investment spending on increasing your fixed assets, for example, building a hospital, buying equipment or building a new road. See also: Gross fixed capital formation

Current spending is expenditure on day to day running costs, for example, government spending on wages of public sector workers or buying raw materials.

One major difference is that capital spending will leave you with assets (e.g. roads, factories, schools). If necessary, these assets could be later sold to recoup some of the capital investment (depending on the level of depreciation). With current spending, you don’t have any assets or any way of recouping the payments (you can’t ask nurses to pay back their wages)

Difference in borrowing to fund current spending and capital spending

There is a difference between borrowing to fund capital spending and borrowing to fund current spending. If you borrow to fund investment, banks who lend money see the assets as collateral. If you default on paying back the loan, the bank can recoup the asset you bought (house or factory) If you borrow to fund current spending, there is no asset which can be sold. This is why banks are more willing to lend large sum to buy a house but not to fund a foreign holiday.

It is the same with governments if they borrow to fund public sector investment vs current spending.

Borrowing for Nationalisation

If a government increases borrowing to fund higher wages on public sector pay, this borrowing is to finance current spending and may become unsustainable.

If a government borrows to fund the nationalisation of a national utility (like for example broadband), then the cost of purchasing the network will be similar to the value. The government’s liabilities may increase by £30bn (cost of buying the company off shareholders), but in return, the government gains assets worth £30bn. Therefore, this borrowing is different – in theory, it could always sell the asset back to the private sector and repay the initial cost.

Is nationalisation really cost-neutral?

The Labour party have suggested their nationalisation plans are close to cost-neutral. How can this be the case, if it costs £30bn to buy out shareholders.

  • If bond yields are close to 0%, like they are in 2019 (actually around 0.6%), then the interest rate cost on buying public utilities, will be very low. If a Labour government nationalised public utilities, it would probably involve giving shareholders an equivalent or similar value of government bonds.
  • The profit margin from national broadband may cover the cost of interest payments.
  • Also, the cost of the debt is matched by the value of the assets. Therefore there is a case for treating this kind of liability different to government debt from current spending. This is the logic for how nationalisation could be cost-neutral.

However, if the nationalised firm became inefficient under public-ownership, profits may fall. Also, the government may need to fund greater investment in the network than it expected, so that would be an additional cost. Also, bond yields may not remain at 0.6% – they could rise – causing an increase in the cost of interest payments.

Why fund broadband nationalisation when NHS is a higher priority?

I saw a video on Youtube, I think it might have been Jonathan Pie, and he made the point, why does Labour promise to spend £30bn on broadband nationalisation – when the NHS is under-funded and it would be better to spend the £30bn on improving health care than free wifi?

You may agree that the NHS is greater priority (or perhaps tax cuts) than broadband nationalisation and offering free internet. But, there is a difference in borrowing £30bn to fund spending on health care and buying a major asset like BT Openreach. If you spend money on healthcare, you will have to borrow or raise taxes. But, there is a case for treating nationalisation of Openreach differently – ‘borrowing’ is funding the purchase of assets which have both future revenue stream and intrinsic value. ‘Debt’ to fund nationalisation could be treated separately to fund current spending. (Some may not call it debt at all)

Related concepts

capital-consumer-goods

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