Underinvestment in the UK

WEEKLY COMMENT 27-03-2014

By Barry Edwards

 Underinvestment in the UK

There was an interesting article in the Financial Times (FT) by Andrew Smithers discussing ‘the right time to raise interest rates`. The Bank of England (BofE) has stated that they have no intention of raising rates any time soon and will continue with the low interest policy until the economy is clearly showing signs of persistent growth that would allow rates to rise.

Andrew Smithers argues that we are approaching that time right now and if the BofE wants to make sure inflation does not start to increase quickly, they should start planning to raise rates. The reason he gives for this point of view is that statistically the cycle of unemployment from recession to steady growth is much lower than it has been historically while the rate of inflation is unusually low at these levels of unemployment.

The chart he shows and the statistics he discusses in his article are well respected by economists and clearly show that interest rates should go up. The BofE has retreated from its previous guideline of considering that rates should rise when unemployment reaches 7% and had they stuck to this view rates would start rising this summer. The reason that unemployment has fallen much faster than expected is because productivity has collapsed, so that a small rise in Gross Domestic Product (GDP) produces a large fall in unemployment.

Productivity is the measure of efficiency of production or work that is a standard percentage figure and analysed by economists worldwide. In the UK, it is noticeably lower than many other countries with higher rates of unemployment. The BofE have said they are mystified by this but Andrew Smithers believes the explanation is straightforward.

The senior management of large quoted companies are rewarded highly if they achieve bigger profits and prefer to buy back their own company’s shares rather than invest in new equipment. Consequently, capital investment has fallen to its lowest level since 1954 and as a result companies that experience a rise in demand for their goods or services prefer to employ more staff rather than invest in modern equipment.

I believe Andrew Smithers has hit the nail on the head with his explanation and all the statistics support his point of view. When larger companies invest in equipment, they are supplied, to a large degree, by medium sized businesses that in turn rely on smaller enterprises for many of the parts that make up the complete new machine of product.

This is the heart of the problem that is restricting growth in the UK and is likely to force many SME’s to look overseas for the orders to allow them to grow their own businesses. Fortunately, the government has realised this is happening and has put in place many schemes to help SME’s do just that. Increasing exports for SME’s is not easy if you are unfamiliar with selling abroad, you need some assistance and back-up to make sure all the regulations are complied with and you have applied for all the licenses that are required. British embassies are getting very proficient at this and the UKTI will work with you throughout the process of obtaining orders. Once you have an order, the UK Export agency will help with funding and provide guarantees for payment.

That is quite a comprehensive support service but most developed countries have similar programmes in place which have been operating for many years. The UK has caught up with other countries and businesses are beginning to take advantage of these services. All this is very beneficial and a great help for many companies but it is like most government policy only providing solutions to part of the overall problem.

Expanding further upon Andrew Smithers main point, the UK economy has struggled to grow because the funding routes for SME’s have disappeared and are showing no signs of returning in this new phase after the financial crisis. That does not mean the previous funding sources was that good but they were extensive and with the right advice and assistance most companies could access finance for growth if they were lucky.

However, unless companies were very familiar with the financial community, it was difficult to find your way through the process of preparing for and approaching funding sources beyond the obvious bank route. The government is trying to correct this but there is no well-practised model that can be copied from another country similar to the export support. We have discussed this many times in this weekly comment and if you have not read this before see The Economic Growth Plan in the right hand column of this page under Categories.  The schemes they have established are fine as far as they go but have a very limited impact and do not include advice and support as part of the package.

Correcting the lack of investment in the UK by large corporates can only be effectively addressed by the government, while implementing the proper support for SME’s could be established by a large financial institution in conjunction with government.  The problem for the politicians is that threatening to remove or even rearrange corporate incentives for senior executives of large non-financial companies directly affects party funding which, as we all know, is sacrosanct. Not much chance there then!!

That means the senior executives of these enterprises have to be persuaded another way and I do not have a suggestion as to what that could be, if you have some thoughts on this let us know. Like many things in this world, we know what the solutions are but implementing them is very difficult when a consensus is required.

That’s all for this week, more observations next week.

 

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