CENTRAL to a rebalancing of the economy away from financial services towards manufacturing have been forecasts of a resurgence in business investment. This is seen as the principal driver of recovery.
The Office for Budget Responsibility (OBR) and others have assumed the economy would be pulled up by its bootstraps by a rebound in business investment to a record high as a share of GDP.
But far from a business investment resurgence, such spending has not recovered and remains lamentable compared with previous periods.
What is the extent of the shortfall? I am grateful to Michael Saunders, UK economist at Citigroup, for the following numbers:
• In real, after inflation terms, business investment is down 19 per cent from the peak five years ago (2007, Q4), a far worse performance than at the same stage of prior recession/recovery cycles. Investment was around its pre-recession peak at this stage of the cycles of the 1970s, 80s and 90s.
• The share of investment in GDP (14.2 per cent) in 2012 is close to the record low (14.1 per cent) seen in 2011. Investment has now been below 15 per cent of GDP for four years running. No other G7 country, Saunders observes, has recorded an investment/GDP ratio below 15 per cent in any year in the last 30 years.
• Net of depreciation, investment in the whole UK economy equalled 2.7 per cent of GDP last year – the lowest since data began in 1960 – down from 6.8 per cent in 2007 and the average of 5.3 per cent of GDP in 1990-2008. Net private investment fell to just 1.5 per cent of GDP in 2012 also a record low, from 5.8 per cent of GDP in 2007. This measure averaged 4.6 per cent of GDP in 1990-2008.
So why is business investment so weak? Companies are certainly not strapped for cash. Indeed, one of the persistent myths throughout our prolonged stagnation is that corporate Britain is strapped for cash.
The opposite is the case. The non-financial corporate has a stonking cash pile of £708 billion in sterling and foreign exchange deposits at banks, equivalent to 45.6 per cent of GDP. This compares with £272bn or 22.5 per cent of GDP ten years ago. And corporate debt has tumbled, from 121 per cent of GDP in the fourth quarter of 2008 to 108 per cent in the final three months of 2012.
Cash for investment? Corporate Britain is rolling in it. To this depressing picture there is one shining exception. UK business investment overseas continues to surge as companies look to build their presence in growth markets across Asia and other regional hotspots.
The level of outward Foreign Direct Investment (FDI) has continued a long and unbroken upward ascent, from £232bn at the end of 1997 to £637bn at the end of 2002. Far from collapsing with the global banking crisis, it has shot further ahead, hitting £1,146bn at the end of last year. When it comes to investment, it seems that ABH – Anywhere But Here – is the prevailing wisdom across corporate Britain.
All this has to be of acute concern for the Chancellor. His three Budgets since 2010 were designed to stimulate corporate spending but have as yet failed to induce any significant change – and many of the measures in the latest Budget are not due to kick in until 2014 or later.
Let’s not minimise the obvious cause for this malaise. The banking crisis delivered an epochal shock with profoundly damaging effects, not only on our financial system but across the UK economy. Domestic demand slumped, causing companies to retrench and shut down loss-making or vulnerable operations. Unemployment rose sharply. Access to bank finance was shut down and has only partly recovered. Household incomes have been hit and with them domestic confidence and spending.
It would be comforting to think that these influences are now at an end. Unfortunately, while banks still have to deleverage and consumers continue to pay down the excessive levels of debt incurred in the 2003-2007 borrowing bubble, no-one can see any quick way out of this aftermath.
Housebuilding, historically prone to the extremes of boom and bust, was in the front line of investment slump casualties. Private housebuilding in the final three months of 2012 was 38 per cent below the mid-2007 peak.
But it has been the continuing slump in business investment overall that has confounded those OBR predictions of renaissance. And contrary to the widespread view that corporate Britain’s £708bn cash pile would be the trigger for a business spending boom, Saunders believes it is the by-product of business decisions to cut back on debt, build reserves while bank lending is unreliable, prepare for a tax onslaught in future years and, in terms of business expansion, focus on faster growing and more promising markets overseas.
“UK firms have been on an investment spree”, says Saunders, “but not in the UK. The UK has become something of a cash cow to generate funds for corporate expansion overseas.” However, and fortunately for the UK, this flow is by no means all one-way. With companies driven to diversify and expand globally, inward investment to the UK has also been very strong. The stock of inward FDI has risen from £174bn at the end of 1997 to £837bn at the end of last year, making the UK one of the world’s most globalised economies. It is to maintain and increase global inward investment to the UK that George Osborne has pressed forward with reductions in UK corporation tax.
But the imperative is to raise the rates of return on domestic business and that is a more formidable challenge than it already looks. Last week the Office for National Statistics reported that the net rate of return on the non-financial corporate sector slipped from 12.1 per cent in the third quarter of last year to 11.5 per cent in Q4, the lowest since the second quarter of 2010.
But looking deeper into this overall figure, the task of rebalancing the UK economy from a finance-dominated service sector to manufacturing looks even more daunting. The rate of return on manufacturing edged up from a record low of 4.6 per cent to 4.9 per cent over the same period, while the return for service sector firms slipped from 17.7 per cent to 15.9 per cent.
This is a huge gap. And until the return on manufacturing is raised, new business investment will be hard to encourage. A lower sterling exchange rate would help, as would help on capital allowances and a continuing drive to reduce labour costs, particularly the tax burden. In the meantime, the best hope for business investment remains an upturn in plant replacement after five years of cutbacks. And this may prove the long-awaited catalyst: an economy can run on string and rubber bands only for so long.