Analysis of attempts to increase investment in UK

 BRIEFING

HUNT IS TO BE CREDITED WITH A SERIOUS ATTEMPT TO TACKLE THE UK’S WOEFUL INVESTMENT RECORD

A boost for Britain’s business investment in the UK

The UK fell behind in the investment necessary for growth. That is about to change, says Simon Wilson

 

WHAT IS “BUSINESS INVESTMENT”?

It’s the money spent by corporations on the physical assets – equipment, machinery, buildings – and non-physical assets – software and other intellectual property – that are essential to producing goods or services. Higher levels of business investment (known by economists as private-sector “gross fixed capital formation”) are widely viewed as central to driving innovation and technological progress, fostering growth and economic stability, and creating high-quality, well-paying jobs over the long run. That’s a view shared by Rishi Sunak, who placed the need to increase business investment right at the centre of his economic agenda for the UK (in his Mais lecture at Bayes Business School, as chancellor in February 2022). The UK’s levels of investment are exceptionally low compared with similar countries. Here, business investment stands at around 10% of GDP, compared with an average of 14% for the rest of the G7 (America, Germany, Japan, France, Canada and Italy). Indeed, according to an analysis by the IPPR think tank, published in June, business investment is now lower in the UK than in any other country in the G7, and 27th out of 30 OECD countries, ahead of only Poland, Luxembourg and Greece.

IS THIS A NEW PROBLEM?

Things got worse following the financial crisis, and got much worse after the 2016 Brexit vote. According to an International Monetary Fund paper published in July (“Enhancing Business Investment in the United Kingdom”), trends in business investment levels have been a key driver of UK growth – and now stagnation – since 1990. In the years before the financial crisis, investment was robust, helping drive the UK’s relatively strong economic performance compared with other G7 nations. But it collapsed in 2008-2010, and has never fully recovered. The level of investment did rise between 2010 and 2016, but the rise was sluggish, falling behind other advanced economies, and it levelled off following the Brexit vote, which led to a sustained period of uncertainty for businesses and unusual political turbulence. Then, during Covid, business investment in the UK again failed to keep pace with its peers and (on IMF figures) settled at a slightly lower level in 2022 than in 2016. By comparison, other G7 economies saw a 14% increase on average during this period.

WHAT’S THE ECONOMIC IMPACT?

Lower productivity and lower growth. According to Jonathan Haskel, an academic economist and external member of the Bank of England’s rate-setting monetary policy committee, the hit to business investment as a result of Britain’s decision to leave the EU is around £29bn. That’s about 1.3% of GDP. But although the UK’s investment problem has worsened since 2016, it predates the Brexit-era instability. According to analysis in a recent London School of Economics report (by Paul Brandily and others), if UK business investment had kept up with the average of France, Germany and the US since 2008 – implying just over 2% of GDP additional investment each year – our GDP would be nearly 4% higher today, enough to raise average wages by around £1,250 a year. And the IPPR, in its report, calculated that if the UK had maintained its position in 2005 – around the average of the G7 – the private sector would have invested an extra £354bn in real terms since then. 

WHAT CAN THE GOVERNMENT DO?

There are many factors that underpin investment decisions – and which help to explain the UK’s lagging performance – ranging from macro-economic and political uncertainty, to borrowing costs, access to finance, and firms’ and investors’ expectations of future profitability. In Jeremy Hunt’s Autumn Statement last month, the government deserves some credit for at last putting forward a “serious attempt” to tackle the UK’s lacklustre investment record, says Helen Thomas in the Financial Times. Crucially, Hunt made permanent the “full expensing” tax break, which allows businesses to deduct 100% of plant and machinery costs upfront from their taxable profits. The move aligns government policy with the long-term planning of companies, and at a stroke “catapults the UK towards the head of the pack in terms of OECD capital allowances”. But what’s still missing is a whole-hearted recognition that “industrial policy is back”.

WHAT DOES THAT MEAN?

The UK has historically been averse to “picking winners” – the notion that industrial strategy involves “anointing” companies as national champions worthy of government largesses, says Thomas. In the UK, there have been 11 different industrial strategies or growth plans since 2010, and a succession of Conservative governments with wildly different ideas on their value. This “hodge podge” of plans, or the lack of them, has resulted in “failing to pick anything at all” – a situation that’s increasingly out of step with the US and  EU. In recent decades, the UK has been in thrall to the idea that public investment will crowd out business investment. In fact, according to the IPPR’s paper (“Now is  the time to confront UK’s investment-phobia”), there is strong evidence that “higher public investment is a core component of enabling private investment, and raising GDP. Public investment can ‘crowd in’ private if it fosters expectations of areas of future growth and profit for firms”.

WHAT POLICIES SHOULD WE PURSUE?

Calmer relations with the EU (following the Windsor Framework on Northern Ireland) will help reduce Brexit-related uncertainty, and should be built on further to increase confidence in the UK, argues the IMF’s business investment paper. Second, the acceleration of well-targeted public investments (for example in the green transition, and healthcare infrastructures) would help lower costs of businesses and “crowd in” private investment. Third, the government could work on ways to unlock pensions and insurance savings, giving firms access to external finance, ideally in the form of equity capital. Government (ONS) data from 2022 put the financial assets of UK pension funds and insurance firms at about £5trn, or around twice the country’s annual GDP. Fourth, the government should improve incentives to invest in research and development, along with improved capital investment allowances and measures to alleviate skills shortages, in order to “address market failures and fuel expansion in new industries and technologies”. Boosting business investment might not be sufficient to arrest the UK’s economic decline. But it will certainly be necessary.