By Daniel Hunter

UK business investment is lagging behind global competitors and won’t return to pre-recession peaks until at least 2015, says a new report out today by the Ernst & Young ITEM Club.

According to the report, investment by UK corporates is still 15% below where it was before the financial crisis — twice as much as in the US and Germany. ITEM Club warns that, despite firms having access to funding, the UK can only expect a slow and steady increase in business spending over the next three years, hampering the wider economic recovery.

The report forecasts business investment growth of just 2.3% this year and 3.9% in 2013, before rising to 8% from 2014-16.

Government urged to create conditions for recovery in business investment

ITEM Club says the Government has a vital role to play in creating the conditions for a strong recovery in investment and restoring confidence. The report recommends that the Comprehensive Spending Review is brought forward to provide businesses with greater clarity over the next phase of the public sector spending cuts, in addition to firming up policy in areas such as energy and environment which have a long term impact.

“Slow and steady doesn’t always win the race. The UK is facing another two years of sluggish growth in business investment, sapping strength from the wider economy," Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club commented.

"The fundamentals are all in place, but a lack of corporate confidence is holding back major spending decisions and is now hampering UK growth and the rebalancing of the economy. There’s a risk that a lengthy period of under investment could also damage the supply side of the economy and reduce our productive potential.”

The recovery in business investment has been much weaker and slower than after previous recessions. If the bounceback had occurred at the same pace as the 1979 cycle, ITEM says that GDP would now be 1.2% higher.

“The desired rebalancing of the UK economy towards a more export oriented model is now, at best, ‘on hold’," Mark Gregory, Ernst & Young’s chief economist commented.

"Without capital investment, British businesses won’t be able to develop the products nor build the capabilities necessary to create the competitive advantage that is required to penetrate new markets successfully.”

However, ITEM Club says this trend is not principally due to a lack of finance. UK corporates have emerged from the recession in relatively good shape and have continued to stockpile cash on their balance sheets. Private non-financial companies are now holding deposits worth over £729bn, a staggering 47% of GDP.

While credit conditions for SME’s still remain challenging, ITEM Club says that it tends to be larger firms which dominate investment spending and they still have good access to bank funding, as well as their own substantial cash holdings.

ITEM Club says the determining factor is low business confidence, which has seen UK firms flex their labour force in order to meet any increase in demand, rather than commit to major capital spending projects. Employment is almost back to pre-recession levels.

Gregory explains: “Business confidence has been undermined by poor economic growth at home and abroad, and the threat of shock waves from Europe and the US fiscal cliff. Rather than committing to irreversible investment decisions, corporates are increasingly choosing to take on new staff or extend working hours in order to meet any increase in demand."
Continuing, Gregory warns that the lack of confidence is leading to many UK businesses sitting on their hands waiting for a sustained recovery before engaging in investment and M&A.

He adds: “This strategy is creating a bias towards risk avoidance and inertia. We are urging companies to evaluate their market and product portfolios in light of the new economic reality, to assess if they offer sufficient growth opportunities. If not, then M&A and investment into higher growth jurisdictions has to be a focus to optimise growth. Critically, businesses need to strike while the iron is hot or they risk playing second fiddle to their competitors.”

As the wider economic recovery takes hold, with falling inflation boosting households’ spending power, and the downside risks melting away, ITEM Club expects corporates to become more bullish about their investment decisions. However, this isn’t going to reduce the size of the corporate cash stockpiles to any meaningful extent: it will merely halt their expansion.

ITEM Club says that the cash flows into private non-financial companies will still be draining £63bn out of the economy in 2015, the equivalent of 3.5% of GDP.

Concluding, Goodwin says that business investment has the ability to be a game changer for the UK economy, however until corporate confidence improves, spending plans are likely to remain on hold. “This is a major if, with downside risks from the Eurozone continuing to dominate the forecast.
“Government has a key role to play.

"Bringing forward the Comprehensive Spending Review and establishing a clear strategy in areas that define the long term economic landscape, such as energy, transport and environment, will provide a more certain framework against which businesses can evaluate their options. However unless corporates also step up to the plate, there is a very real risk that the recovery will continue to disappoint and the Government’s austerity plan will be knocked further off course.”

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