UK businesses are underinvesting

A new investment landscape …

Much has changed since the EY ITEM Club: Special report on business investment in 2015. At that time, the UK was in the fifth year of a strong recovery in business capital spending and the expectations were that this would continue as the economy appeared set to carry on growing strongly.

… shaped by political uncertainty …

The new EY ITEM Club report sets out how much the environment for investment has changed with the UK’s vote to leave the European Union (EU), a clear source of increased uncertainty. 2016 was a poor year for business investment in the UK, as activity fell and the UK growth rate slipped relative to our peers in Europe.

Uncertainty over the terms on which the UK will leave the EU casts a shadow over business decision-making, but business investment has performed reasonably strongly in 2017, reversing at least some of 2016’s decline.

… is making forecasting difficult …

Forecasting future levels of UK business investment is therefore very challenging against this backdrop. Nevertheless, it is encouraging that EY ITEM Club remain optimistic that there is still time for the UK and the EU to agree on a transition arrangement that will support steady growth in expenditure in the coming years.

EY ITEM Club believe that growth of 1.5% in 2018 could be followed by increases of 2.7% in 2019, 3.4% in 2020 and 3.3% in 2021. These projections are of course very dependent on progress being made in the Brexit negotiations.

… but underlying concerns remain …

However, while I am encouraged that EY ITEM Club are more optimistic around business investment than I expected, challenges remain. In particular, I am concerned that the UK is not investing enough to maintain and improve our competitiveness and productivity levels.

Despite improved performance between 2010 and 2015, the UK’s record on business investment still lags some way behind its international competitors — with the UK consistently falling short of its G7 peers in terms of share of GDP devoted to business investment. While it is true that the more service-intensive nature of the UK economy may mean that the UK requires less business investment than its peers, I do not believe this supports the current disparity in investment levels.

This issue has become more acute since the 2015 report as there are now a number of factors that suggest that UK businesses need to invest more:

• Adjusting to the consequences of Brexit will require shifts in the UK economy, especially in domestic supply chains, and this will require investment.
• As the global economy recovers, UK businesses should be investing in enhancing their export capability to capture new export opportunities.
• The UK’s productivity performance remains weak and increased business investment is almost certainly required as part of the approach to improving current levels.
• Technological change continues apace and businesses will need to ensure they are investing sufficiently to capture the benefits and hence retain their competitiveness.

… and policy support is required.

Brexit is likely to give a significant shock to the economy and makes the case for policy to incentivise investment even stronger. Government can improve the investment climate by providing increased resources to improve skills, training and the provision of infrastructure — this will serve to de-risk business investment by creating an environment in which businesses believe their chances of earning a return on their capital investment are increased.

As EY ITEM Club note, financial conditions remain favourable for investment as profits and returns on capital are at relatively high levels, and corporates have access to both cash and credit. Nevertheless, investment is not increasing at the rate we might expect. Uncertainty is clearly a factor, but more direct incentives, such as increased capital allowances, should be considered as ways to increase investment levels.

Download the EY ITEM Club: Special report on Business Investment

@MarkGregoryEY

EY ITEM Club is part of our Economics for Business programme which provides knowledge, analysis and insight to help businesses understand the economic environments in which they operate.