Why is the UK lagging behind when it comes to business investment?
September 26, 2023
Business investment, which accounts for about 13 per cent of the UK’s GDP, has lagged behind other developed economies for decades. It has been an average of 36% lower than other members of the G7 since 1990 according to a report published this year by The International Monetary Fund (IMF).
Looking at the latest disruptions caused by Brexit, the pandemic and the invasion of Ukraine, the IMF also confirms that real-terms business investment in the UK had settled at a slightly lower level by the end of 2022 than in 2016 while other G7 economies experienced a 14% increase on average over this period.
Why is business investment important?
The link between business investment and GDP growth is an accepted economic fact, though quantifying it is more tricky. The government’s Plan for Growth from 2021 quotes a study that argues that a 10% increase in infrastructure capital is linked to a 1–2% increase in GDP. Other research has found that the elasticity of GDP related to the stock of capital in the economy is between 0.2 and 0.3, so a 10% increase in the UK’s capital stock would raise GDP by 2–3%. With our economy currently predicted to see sluggish annual growth below 1% through to the end of 2025, we could certainly do with a serious surge in business investment.
What drives business investment?
For all the academic analysis and punditry, there are three basic factors that prompt business investment: confidence, the desire to grow a business and, less often mentioned, a recognition that without investment, all businesses eventually deteriorate.
What does the government think drives business investment?
A report earlier in 2023 from the independent thinktank, the Institute for Government suggests that current government thinking is that a stable economy and tax incentives are the key factors prompting entrepreneurs. In addition, it is in favour of targeted financial support for major projects, such as the building of the new all-electric mini by BMW at Cowley. The economy does at least seem to be stable, even if it is bumping along the bottom of a minimal growth trough.
What do business leaders want as incentives?
Surveys of entrepreneurs show a quite different view. Tax incentives such as the recently withdrawn 130% ‘super deduction’ for capital expenditure are welcome, but few think they could ever be the deciding factor. Other considerations are ranked higher by many, such as the availability of skilled labour, the existence of effective local transport and other infrastructure and access to affordable housing. Above all else, what makes businesses invest is a tolerable level of economic and political certainty, or at least the absence of too much uncertainty.
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Policy uncertainty
Constant policy churn is an important factor in causing short-termism and creating barriers to investment. Even without Brexit, the past few decades have seen regular changes in the posture towards industrial strategy, regional policy, business advice, skills policy and more.
The government’s capital budgets have been raised, slashed and raised once more. Tax policy for business has been subject to numerous changes, even while the headline rate was steadily lowered; capital allowances, the treatment of small business, dividend taxation and capital gains taxes have all been ‘reformed’ from time to time. Local planning reform announcements and changes have left the housebuilding and renewable energy sectors bewildered.
Interest rates
After more than a decade of ultra-low interest rates since the global financial crisis, the Bank of England has raised rates fourteen times since the end of 2021 and we are firmly into a new era of higher interest costs for businesses. This inevitably changes calculations about the viability of some capital projects and makes the task of encouraging more investment even harder.
Borrowing aversion
Around half of UK business investment is done by the engine room of the economy, our SMEs. In a recent British Venture Capital Association survey of smaller businesses, almost half of respondents described themselves as “permanent non-borrowers”, while 75% stated that they would choose a lower rate of growth if it meant that they could fund the expansion of the company from their own resources.
In addition to this phenomenon, our research into the finances of sectors such as retail and hospitality has confirmed that borrowing by smaller businesses had soared two or threefold during the pandemic as they took up Bounce Back Loans and other ‘survival’ facilities backed by the government. These companies will be too busy repaying these loans to contemplate borrowing yet more for investment projects.
What are the prospects for a rise in business investment?
The best guess might be ‘mixed’, given all the potential adverse factors, but not investing is really not an option for a business. In that scenario, it won’t just be fixed assets that will be depreciating, it will be the whole business.
If you are seeking professional advice on funding and investment for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.