Markets

With higher taxes in the offing and costs rising, 2022 is a make-or-break year for corporate investment

The market’s fixation with the cost-of-living crisis overlooks a much deeper challenge facing the UK economy longer term: flatlining business investment.

The covid pandemic inevitably sent business investment on a rollercoaster ride, but the steep falls seen over the past two years haven’t yet been fully recovered. Gross Domestic Product (GDP) is back to pre-pandemic levels, butbusiness investment remains substantially below – to the tune of 8.5%. As a percentage of GDP, it’s close to decade lows (see below). 

 

Business investment in the UK (percentage of GDP)

Sources: Office for National Statistics, NatWest Markets

Despite the fact that higher business investment spending doesn’t always fully translate into real economic growth (the ‘dot com’ bubble in the late 1990s/early 2000s comes to mind), the link between them has become stronger over the past two decades. That’s why sluggish business investment – over a period of years, not weeks or months – should be concerning, and why efforts to boost it are so crucial.

 

Fiscal incentives need a re-think

The recent period of comparatively sluggish investment has coincided with large tax breaks, but those don’t seem to have done much to boost capex. Introduced in the March 2021 Budget, capital allowances or ‘super deductions’ worth some £12.3 billion in 2021-22 and £12.7 billion in 2022-23 were supposed to help spur new business investment, or at the very least bring forward planned corporate spending ahead of corporations tax rises due in April 2023 and beyond. But unfortunately, that didn’t come to pass: business investment, which slumped by 11.5% in 2020, rose by just 0.8% in 2021, leaving it just 1.0% above levels seen a year earlier.

A closer look at the makeup of spending may provide some clues as to why business investment hasn’t translated into higher productivity or growth (see below). Investment in the transport sector, notably airlines, has been particularly weak. By contrast, home-building boomed. Whilst home-building does support underlying productivity – by supporting labour mobility, for example – this probably has less impact on productivity growth than, say, investment in ICT and machinery. Technology and machinery investment spending is 5.9% above pre-pandemic levels, by no means disastrous but somewhat underwhelming given the scale of capital allowance tax-breaks – which have mostly centred on technology and machinery.

 

Capex components (100 = Q4 2019 levels)

Sources: Office for National Statistics, NatWest Markets
Businesses have great (investment) intentions but they’re being held back

Business investment intentions surveys rebounded firmly during 2021 with the easing of covid restrictions but actual investment hasn’t been as forthcoming, particularly since the third quarter of last year (see below). More recent surveys of businesses do seem to factor in the persistence of energy and supply chain shocks, but that only tells part of the story.

 

Business investment: intentions vs. actual 

Sources: Bank of England (BoE), British Chambers of Commerce (BCC), Confederation of British Industry (CBI), NatWest Markets. Right side = percentage year-on-year, left side = investment intentions from aggregated surveys.

What else are businesses worried about? Recent CBI surveys suggest ‘demand uncertainty’ is the principal factor (despite seeming to hover around long-term lows) holding back fresh investment, followed closely by ‘labour shortages’ and ‘low returns’. 

 

Factors holding back investment (percentage of respondents)

Sources: CBI, NatWest Markets

The first of these is probably best interpreted as pessimism about the strength of the economy in the near term, but the other two may speak to more structural challenges. It’s hard to draw any definitive conclusions but concerns about low returns or labour shortages may be increasingly common features of the post-Brexit trading environment. Supply chains linking the UK with its closest trading partner are costlier and less efficient following the vote to leave the EU, a trend that appears to be reflected in the stats: UK trade with the EU has consistently underperformed its activity with the rest of the world since the split (see below). This will inevitably weigh on hiring and investment.

 

UK trade: EU vs. Rest of World (RoW) compared

Sources: UK Office for National Statistics, NatWest Markets. January 2020 = 100
Where next for business investment?

We see business investment moderating over the next few years as post-pandemic spending continues to normalise, but we’re slightly more pessimistic in the near term and more optimistic than most in the medium term (see below).

 

Investment forecast (percentage year-on-year)

Sources: BoE, Office for Budget Responsibility (OBR), Bloomberg, NatWest Markets

There are some important nuances among these forecasts. The OBR for instance is more optimistic about the impact of the super-deduction, albeit half as much as initially estimated. The BoE, on the other hand, sees supply and labour shortages conspiring with rising costs to constrain business investment in the years ahead. Perhaps unsurprisingly, it sees investment from sectors hardest hit by the pandemic as slowest to recover (retail, entertainment, transport).

Get in touch

To discuss the outlook for business investment, get in touch with your NatWest representative or contact us here.

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