Can behavioural psychology convince companies to stop

20th July 2012

In April Ernst & Young's ITEM Club issued a report showing that cash balances of private non-financial companies are worth over £754 billion, or more than 50% of UK GDP. These gargantuan capital reserves have been built up as businesses slashed costs during the financial crisis and have yet to start investing the savings into growth opportunities.

Unfortunately for Britain's prospects, it will be difficult to achieve any meaningful growth while the corporate sector is busy hoarding cash rather than ploughing money back into the broader economy. Moreover the Bank of England's quantitative easing programme will struggle to have any impact while the corporations selling their gilts refuse to move excess reserves off their balance sheets.

Fears of further trouble in Europe may explain the caution of businesses but their timidity is trapping them into a vicious cycle of cash build-ups worsening economic prospects, which in turn encourage an increase in reserves. Due to this traditional policy moves aimed at improving the business climate, such as a drop in corporation tax, have a negative effect as they reduce government tax revenue without any compensatory increases in corporate spending.

So what can be done?

One option worth considering would be to look again at "nudge theory". Popularised by Richard Thaler in his book "Nudge: Improving Decisions About Health, Wealth and Happiness", the theory attempts to offer policymakers a system that "helps people choose what's in their best interest".

The frequently cited example is an Amsterdam men's public toilet where, in order to encourage proper use of the facilities, authorities had a designer draw a fly near the centre of the urinals. The result was a sharp reduction in wet floors.

On taking office, David Cameron set up his own "nudge unit" in the Cabinet Office dubbed the Behavioural Insight Team, whose task was to help citizens behave in a more socially beneficial way. In February this year the team released an update on its activities in relation to fraud, error and debt in which it claimed that "if trialled on a national scale, we expect that these interventions will save hundreds of millions of pounds".

No doubt Mr. Cameron will be pleased to note the apparent success of his pet project. Yet while the Tory leader is happy to countenance using subtle signals to correct the behaviour of the citizenry, there seems to be little enthusiasm for applying similar techniques to the Coalition's economic policy.

At the last budget in March, the Chancellor cut corporation tax from 26% to 24% and announced it would drop to 22% by 2014. Although the government claimed the budget "unashamedly backs business" it offered no answers as to why boardrooms can be assumed to be brutally rationalist when it comes to managing their businesses, but are not to be trusted when using public urinals.

One possibility would be putting a small, temporary tax on retained corporate earnings. This could work alongside the already announced corporation tax making it more appealing for companies to put their cash to work faster without being overly punitive.

It its report Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club, provided a worrying account of allowing the status quo to be maintained.

"Until these companies stop stashing the cash and start increasing levels of investment and dividends, the economy will remain on the critical list."

Perhaps this could be considered a nudge for the Coalition to act.


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