We all need cheering up in early January, when the days are short, the weather is iffy and the credit card and tax bills are coming in. So I have been looking for something that might provide a bit of a lift.
You will know that, in a crowded field, business investment has been one of the more disappointing features of the economy in recent years, particularly so over the past few months, when the 130 per cent “super deduction” for qualifying investment spending against corporation tax was supposed to provide a boost. It expires in April, when the corporation tax rate also goes up from 19 per cent to 25 per cent, so time is running out. Official figures show that business investment fell by 2.5 per cent in the third quarter of last year and was a hefty 8.1 per cent below the pre-pandemic position, lagging a long way behind the rest of the economy. Having stagnated between the referendum and the pandemic, the latest readings showed investment running at 2015 levels. Not good at all.
However, I was surprised and encouraged to see a pair of surveys over the past couple of weeks suggesting that companies are becoming more confident about the economy and investment. The Institute of Directors’ economic confidence index, published on New Year’s Eve, showed a small improvement in overall business confidence and, importantly, in investment intentions. Nearly a third of firms, 30 per cent, plan to increase investment this year, against 21 per cent who plan a reduction.
“Confidence in the economy is still very low, but is pointing upwards into the new year,” Kitty Ussher, the institute’s chief economist, said. “It is hugely encouraging, in particular, that the investment plans of IoD members are a little stronger in December than at any time in the last six months.”
There were also signs of improvement in the Lloyds Bank Business Barometer. Though it did not report specifically on investment, it noted that overall business confidence had risen by seven points to its highest level since last summer, with the largest monthly rise in confidence since April 2021, when the country was emerging from the final Covid lockdown. Hiring intentions were up, as were business expectations of trading conditions over the next few months.
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A rise in business investment would be a welcome surprise. The Office for Budget Responsibility, the official forecaster, predicts a 2.1 per cent drop this year and in November it took an axe to its previous forecast in March, lowering business investment by 6.7 percentage points over the forecast period. Its latest forecast implies that business investment will not recover to pre-pandemic and pre-referendum levels for at least another three years. April’s corporation tax rise, it says, will lower the economy’s potential output, its growth potential, by an eventual 0.3 per cent.
Tax design is quite important. The Lawson corporation tax cuts of the 1980s, funded by the removal of tax reliefs, were successful in boosting business investment, though other factors may have been at work, too. Cutting the headline rate of corporation tax in the 2010s did not boost business investment as much as had been hoped, partly because the effective rate of tax remained relatively high, even before the big dampening impact of the Brexit vote.
The coming increase in corporation tax is without any significant offsets in improved investment incentives. When he was chancellor, Rishi Sunak promised to bring forward an more investment-friendly tax environment in the autumn, even with higher corporation tax, but November came and went and it never saw the light of day. Perhaps there will be something in Jeremy Hunt’s March 15 budget, but that would be cutting it fine.
Why is business investment so important? Because without it we are unlikely to see the recovery in productivity that is needed for a stronger long-run growth rate, sustained increases in real wages and thus rising prosperity.
For some sectors, an investment recovery is hard to see. The latest purchasing managers’ survey for manufacturing showed “the UK manufacturing sector ended 2022 on a weak footing, with output, new orders and employment all falling at faster rates”. Make UK, which represents Britain’s manufacturers, reported in its latest survey that investment intentions had turned negative for the first time since early 2021, when the economy was in lockdown.
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For businesses in general, we should look to the views of those who hold the purse strings, the finance directors. The latest Deloitte survey of chief financial officers showed that if raising interest rates was intended to reduce the attractiveness of debt, the medicine is working. With Bank rate at 3.5 per cent and set to go a bit higher, borrowing is less attractive than at any time since 2009, the finance chiefs said.
On the face of it, this means a gloomy outlook for business investment. Chief financial officers are downbeat on both capital spending and hiring, with a net 62 per cent and 59 per cent, respectively, expecting their organisations to cut rather than increase. They are a lot more downbeat on investment than business leaders.
Yet there was better news on investment in digital technology and assets, with a net 79 per cent expecting an increase. If technologies such as artificial intelligence are the key to lifting our economic performance, raising productivity — a new version of Harold Wilson’s famous white heat of technology — could be the most promising light at the end of the tunnel that I can provide. Mind you, it still looks like quite a dark tunnel.
David Smith is Economics Editor of The Sunday Times david.smith@sunday-times.co.uk
