Are UK businesses investing enough? The latest EY ITEM Club report shows UK business investment is strong and growing.

UK businesses are investing…

Over the past few years, there has been a widespread perception that the UK economy has been performing relatively poorly in terms of business investment. This view has fuelled fears that the UK could slip into ‘secular stagnation’ – a scenario where a combination of high savings and low investment acts as a brake in growth. Earlier this year, the IMF raised the prospect that the entire global economy could suffer such a fate.Chart1

The good news is that the latest EY ITEM Club special on Business Investment suggests that – for the UK at least – such worries are not just overdone, but actually misplaced. The report finds that UK business investment has been outpacing other economic indicators since 2010 to reach its highest level as a share of GDP since 2000. The report reveals a much more optimistic picture than many, including myself had expected.

…and will continue to do so…

Especially encouraging is that the outlook for business investment in the UK remains positive. EY ITEM Club believe the UK is set to remain a relatively conducive environment for business investment in the coming years, encouraged by factors such as falling corporation tax rates, plentiful corporate liquidity, and greater certainty around issues such as market demand and the availability and costs of finance.Chart2

Encouragingly, EY ITEM Club’s projections show investment by UK business rising by an average of 6.4% a year between 2015 and 2019, to reach a high in real terms of 12.9% of GDP, a level not seen in the UK for over 3 decades. This is broadly in line with the OBR’s July 2015 forecast, which saw the investment/GDP ratio rising to 13.1% of GDP in 2019.

 

…and it may even be better than the data suggests…

It is also possible that the forecasts understate investment. One of the most striking developments identified in the report is the dramatic changes in working practices in recent years and the implications for investment.Chart 3

The growing ranks of the self-employed and home-workers apparently means that some investment in technology, such as smartphones, tablets, home printers, to support work is now classified as consumer spending rather than business investment. As a result, the official figures may be missing some of the expenditure. The gathering momentum behind the ‘sharing economy’ suggests this effect may increase in the years ahead.

…although still not at best practice levels…

However, while there’s cause for greater optimism around business investment, the UK’s record still lags some way behind its international competitors – with only Italy among the G7 seeing it account for a smaller share of GDP.

Chart 4

That said, the continued growth over the next few years will narrow the gap, and see the UK rise at least part way up the global rankings. Nevertheless there is a risk UK business is still underinvesting when judged on a global basis.

Are you investing enough? 

So, what are the implications of all this for UK business? The first question businesses should ask themselves is whether they have been investing enough to ensure their on-going success. Given the general view that investment has been low in the UK, it is possible that businesses have been assuming there was less investment going on than has actually been the case. This has typically applied most obviously to international peers, whose investment levels have been higher on average – but based on the EY ITEM Club’s analysis, it might also now apply to UK focussed businesses as well.

In analysing the adequacy of their investment, businesses should start by assessing if the historic level of investment revealed in this special report been sufficient to lay down a platform for sustained growth in the UK. This will provide them with the insight into the extent that their current business forecasts reflect the potential of the UK economy to grow over the coming years.

It is also important for businesses to reassess their investment plans in the context of the changed environment identified in this report. Examples include the increasing role played by consumer technology in sales processes and the rising incidence of sharing in appropriate areas of the value chain, enabling businesses to share investment and effectively boost returns. It may well be that the level of investment and hence potential demand is higher than might be reflected in current plans.

The impact of investment in technology has at least two dimensions. Yes it might mean that there is more demand than previously assumed but it may also mean that businesses need to invest now to head off the disruptive threat from technological change. For example, have sales channels being optimised to reflect the impact of the smartphone on customer behaviour?

Finally there is a need to consider the potential impact of the introduction of the National Living wage from 2016. As the EY ITEM Club report highlights, the relative costs of capital versus labour have changed in recent years as labour has become relatively more competitive. For some sectors, the NLW will reverse this trend and business investment may therefore become both more attractive and necessary to offset increased labour cosChart 5ts.

Overall, the brighter picture for business investment revealed by this special report is good news for the UK economy. But it  raises challenges and questions and businesses do need to move quickly to reassess their asset base and investment intentions to ensure they are not left behind.


 


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