Sunday, March 06, 2022
Britain is dire at investing - and now there's an energy shock
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

If it was not clear a week ago, we can now see that, in addition to the horrors unfolding in Ukraine, a big price shock is unfolding. The oil price, having risen and then dropped back in the immediate aftermath of the Russian invasion, has nudged $120 a barrel. The gas price, even more in focus at present, has followed a similar pattern and tested last year’s highs.

The immediate impact of this, and of Europe’s efforts to reduce dependence on Russian oil and gas, will be to intensify and prolong the cost-of-living crisis. Inflation is heading higher than the Bank of England’s predicted peak of 7.25 per cent later this spring.

More significantly, an important part of the inflation story had been that the second half of this year would see energy prices settling down after their winter surge. That way, as well as the easing of non-energy supply shortages and other temporary factors, there was a clear path to lower inflation. Forecasters surveyed by the Treasury last month expected inflation to end this year at between 4 and 5 per cent.

Now, however, the energy shock has emerged as a risk to that. The renewed rise in gas prices threatens another big rise in the energy price cap in October, something that was not incorporated in the forecasts. Though these are early days – the October cap will be set in August on the basis of forward wholesale gas and electricity prices over the previous six months – the omens are not good. Energy prices need to come back down quite soon to save consumer from another, potentially eyewatering, increase in energy prices.

There is another aspect to this, which I wanted to focus on today. Ten days ago Rishi Sunak set out some big thoughts on the economy, in his Mais lecture at London’s City University. He was treading a familiar path, previous chancellors having used the same platform for important speeches describing their economic philosophy. Sunak’s, delivered just as the Russian tanks were starting to roll into Ukraine, did not get as much attention as it might have done in other circumstances. The chancellor has himself been preoccupied with Russian sanctions.

One of his central messages was the need for the UK to increase business investment. One comparison that has stayed with me was from the Office for National Statistics a while ago. It showed that, taking public and private investment together, over the period 1997 to 2017, the UK invested less as a percentage of gross domestic product (GDP) than any of the 30-plus members of the Organisation for Economic Co-operation and Development, the advanced economies’ club.

Nor was it close. The UK’s average over that period, 16.7 per cent of GDP, was three percentage points lower than the next lowest, Italy, and only just over half the highest, South Korea. Since then, at least s a far as the private sector component of investment is concerned, things have got worse rather than better.

The EU referendum, and the vote for Brexit, brought the recovery in business investment after the financial crisis to a halt. The pandemic drove it down again and it is yet to properly recover. Last year business investment in real terms was down by more than 12 per cent compared with 2016. Over the previous five years it had grown by 34 per cent.

There are two questions that arise now about business investment. The first is the extent to which ti recovers this year. The second, raised by Sunak, is whether it can be lifted to match competitor countries.

On the first, I noted recently that, channelling Elvis Presley, this year is now or never for business investment. Firms have just over 12 months to take advantage of the chancellor’s 130 per cent “super deduction” against corporation tax, after which the tax will rise from 19 to 25 per cent and, on present plans, the additional incentive will disappear.

This is why the energy price shock is so unfortunately timed. History tells us that such shocks are toxic, not just for consumers, but for businesses, who respond by cutting back on their investment plans.

There is a caveat. Much of the evidence and research on the impact of energy shocks dates from the Opec (Organisation of Petroleum Exporting Countries) oil price hikes of the 1970s and early 1980s. This was a time when industry, and in particular heavy energy-using industry, played a much bigger role in the economy. The impact of energy shocks may be less in a service-based economy.

The jury is out on this. Even before the Russian invasion forecasters had scaled back their prediction for business investment this year, though still expected a significant increase. The British Chambers of Commerce, however, in a new forecast, has revised down its prediction for business investment growth this year to just 3.5 per cent. It remains to be seen what the Office for Budget Responsibility (OBR) will come up with in its new forecast later this month. In late October last year it predicted a business investment boom this year, with a predicted rise of 15.7 per cent.

In some respects, firms remain in expansionary mode. The latest picture from the Recruitment and Employment Confederation (REC) showed a strong increase in advertised jobs in the final week of February. There were, it said on Friday, 1.82 million active job adverts, with a 224,000 increase in the latest week, the biggest since early December.

We can hope that willingness to recruit extends to willingness to invest. Purchasing managers’ surveys show that, in the UK and elsewhere, February was a month of bounce-back from the Omicron variant of the coronavirus. Now that Covid has been pushed off the news bulletins and front pages, it has been replaced by a new uncertainty.

That will pan out in coming months. What about lifting the UK’s investment over the medium and long term, which is the key to raising productivity?

In his Mais lecture, Sunak pulled no punches. Business investment in the long run in Britain averages 10 per cent of GDP, he said, compared with an OECD average of 14 per cent. And, anticipating, what some see as an excuse for the UK’s poor record, he was clear.

“The lower level of capital investment we see by UK businesses is not primarily driven by the sectoral composition of our economy, or by differences in firm size, and is observed across all regions,” he said. “This is a pervasive economy wide issue, it has been persistent for decades, and we must fix it to improve productivity, growth, and living standards. Indeed, we need the private sector to invest to level up this country.”

The government, through increased infrastructure spending, is playing its part by raising public investment. But what about businesses? His diagnosis is that the tax treatment of investment is less generous than in other countries and that that needs to be fixed. Cutting corporation tax did not provide a spur to investment, as pointed out here before.

What kind of tax incentives would work? That is what the chancellor will be examining in the next few months, leading up to potential action in his autumn budget. The CBI has already set out a marker, by calling for a version of the super-deduction, but pared back to 100 per cent tax relief on investment, to be made permanent.

That, though, looks too expensive, costed by the Treasury at £11 billion a year, the cost of a more politically appealing 2p reduction in the basic rate of income tax. Whether meaningful incentives can be introduced at much lower cost is something Treasury officials will be scratching their heads over in coming months.

It is not all about tax incentives. New technologies such as artificial intelligence (AI) offer opportunities for investment, as does the transition to net zero. But that applies to other countries too. Sunak has identified the UK’s investment problem. Whether he can cure it is another issue.