Wednesday, September 10, 2003
When will the investment upturn come?
Posted by David Smith at 09:52 PM
Category: David Smith' s magazine articles

Just when industry thought that the investment picture could not get any worse, it has. This was the time when many were looking for a recovery in capital expenditure, on the back of a strengthening world economy and, for exporters, a more competitive exchange rate.

Instead, the latest figures were little short of disastrous. Overall business investment dropped in the second quarter to 26.8 billion. This was a drop of 1.1% compared with the first quarter and 3.5% in comparison with a year earlier.

For industry, there was even worse news in the detail. Capital spending by manufacturers dropped by 10.1% during the quarter to 3.3 billion, and was 13.3% lower than a year earlier. From its recent peak of 4.5 billion in the first quarter of 2001, manufacturing investment is down by 25%.

Not only was the latest quarterly fall the biggest on record for the sector but, according to the Engineering Employers’ Federation, manufacturing investment this year is heading for its lowest total, relative to output, since 1970. Martin Temple, its director-general, says that pension shortfalls, higher National Insurance contributions and sharply rising liability insurance bills are squeezing firms hard. On top of this managers lack that vital ingredient for investment, confidence in a global economic upturn.

The weakness of investment, the CBI points out, is bad news for Britain’s future ability to compete. Just when firms should be investing to improve productivity, and thus take advantage of sterling’s lower level against the euro, they are cutting back.

Ian McCafferty, its chief economic adviser, says levels of investment are “worryingly weak”, adding that: “Corporate investment - on which so much of this recovery depends - will continue to constrained by weak global demand, excess capacity, low returns and increased cost burdens such as pension provision.” He sees business investment at best flat between now and the end of next year.

A new paper by the Institute of Directors, “Uncertainty, uncertainty, uncertainty – the outlook for business investment”, takes a similar view on the outlook. There are one or two positive factors in the short-term investment outlook, it says, notably lower prices for IT-related equipment.

But negative factors dominate. They include subdued profit expectations, continued high levels of corporate gearing, a capacity overhang from the investment upswing of the 1990s, pension-fund deficits, global economic weakness and persistent deflation worries, and geopolitical uncertainty. That does not mean investment will not recover. It does mean we should not hold our breath.

Where the IoD takes issue with other business bodies is on the implications of the current investment downturn. It points out that there was what it describes as “an explosion” in business investment in the late 1990s, with a rise of 45% over the 1995-98 period.

Despite the fall of the past 2-3 years, levels of business investment, it points out, are as high relative to gross domestic product as at the peak of the last cycle in the late 1980s. That is not true for manufacturing, clearly, although it does hold for business taken as a whole.

The IoD also suggest we should not be too obsessed about pursuing higher investment for its own sake. Japan has had had a history of high investment but for a decade now has been the least successful of the world’s big economies. Britain has a flexible job market, in contrast to much of the rest of Europe, so somewhat lower capital-intensity – more workers and less equipment – might be justified.

There’s a bit of truth in these arguments but you can only take them so far. France, for example, has 80% more capital for each worker than Britain. Not only that, but while levels of service-sector investment in Britain look adequate, and indeed remain quite buoyant, this does not apply to manufacturing.

Another new report, from the Institute for Public Policy Research, “Manufacturing in the UK”, takes the view that we do indeed need a manufacturing investment boost. “It is not in question that the UK manufacturing sector operates with a significantly lower capital stock than comparable countries and that this materially affects its relative productivity,” it says.

The report argues against boosting investment allowances, although it says the competitiveness of the corporate tax regime should be kept under review, and that specific investment support measures from the government have been poorly designed and monitored.

Its broad conclusion is that manufacturing investment was particularly hard hit by sterling’s strength against the euro. Now that the pound is at a lower level, this, combined with a period of macroeconomic and microeconomic stability, should produce the necessary investment upturn.

It may not happen straight away but, if the analysis is right, it will not be that long in coming. Let us hope so anyway. Otherwise industry’s future would be rather bleak.

From Industry magazine, September 2003