Business Investment: The Key to UK Economic Recovery

Sifting through the small print of the Chancellor’s Autumn Statement, which could be summarised as very much a “steady as she goes” story, one finds the breakdown of the UK economic forecasts generated by the Office of Budget Responsibility. It shows that the sector of the economy which is expected to lead the UK economy back towards growth is Business Investment, which further analysis shows is forecast to grow at a compound annual rate of 9.5% from 2014 to 2017.  Over the same period, Household Consumption is forecast to grow at a compound annual rate of just 2.2%. Of the four key economic sectors that can drive growth, Household Consumption, Business Investment, Government Spending and Exports, only Business Investment is currently in a position in the UK to lead a recovery.  The Household and Government sectors are both suffering from very high levels of debt and pressure on their incomes and are therefore working hard to curtail spending.  The remaining sector is Exports, but with over half of the UK’s exports going to the rest of the Europe, which is expected to fall back into recession in 2013, export-led growth for the UK economy looks a very distant prospect.

The Chancellor announced two new surprise measures in the Autumn Statement to encourage businesses to invest. The first was to cut the rate of Corporation Tax by another 1% to 21% from 2014, leaving it well below the rates set by other western nations, and a tenfold increase in the tax relief granted on investment by small businesses for 2013 and 2014.  This government has consistently sought to reduce the rate of Corporation Tax since it came to power as an incentive for businesses to invest, grow and create employment in the UK.

Though the growth rates have been quite low at 2.9% and 3.8% for 2011 and 2012 respectively, which have not been sufficient to get the economy as a whole moving strongly, Business Investment has in fact been the fastest-growing part of the UK economy. Businesses themselves cite two factors when asked why they are not investing more. One is the readiness of the UK banking system to provide loans to finance investment and the other is a lack of confidence in the economic outlook and hence the generation of a sufficient return on any investment. The Chancellor and the Bank of England have worked together to create the recently-launched “Funding for Lending“ scheme, which provides cheap liquidity for banks who will actually use that liquidity for new loans. In the first two months of the scheme, only £500m has so far been lent out of a possible £80bn, which is disappointing. If this does not improve soon, then the only explanation left for slow investment growth is a lack of confidence from businesses in the outlook for demand.

Most entrepreneurs are natural optimists, always believing and seeking to do more business and make more profit. In long periods of little or no growth, such as that which is being currently endured, then such optimism can get squashed by consistent economic disappointment. Normally, the dynamics of capitalism mean that in the downturn, loss-making or unsuccessful businesses withdraw from the market. This shrinks the supply in that industry, so enabling their more efficient competitors to boost their market share and become more profitable.  However, the recent revelation that 1 in 10 UK businesses are zombie companies, which are effectively bankrupt but are being kept alive by ultra-low interest rates and the reluctance of the banks to admit to more bad debts, is disturbing. This indicates that this normal operation of the free market system in economic downturns is not currently occurring, leaving less scope for more efficient companies to take the opportunities for them to grow.

There are only two strategies that the UK Government can follow to generate growth. The first is for the Government to use its strong creditworthiness to borrow in the markets and spend the money productively by, for example, building houses and necessary infrastructure projects.  However, if the money were to be spent less productively, it would merely raise the level of public debt that future generations will need to repay. The second strategy, which is this government’s preference, is to give the private sector every reason to want to invest, and lead the economy back to growth.  To create the required optimism amongst businesses, it would, paradoxically, help if more companies were made to go out of business.  The costs of this though are more jobs lost and more losses for the banks in the short term, before the opportunities for the survivors can improve.