Short-term approach by British business holds back investment

Surveys which ask companies to list the biggest obstacles to new investment regularly blame uncertainty about demand

Why is investment so low in the UK? Why has it grown so little during the recovery? This is one of the puzzles economists most like to set themselves, and one of the Labour Party's favourite sticks with which to beat the Government over its record on the economy.

The difficulty in answering these questions is trying to find an explanation that applies to the UK and US, but not to other industrial economies, for the Anglo-Saxon share of investment in GDP at 17 per cent is strikingly lower than the investment share on the Continent, or in Japan, at 20-30 per cent. This is why institutional explanations are favoured by many commentators, like Will Hutton, who pins much of the blame on free-wheeling and short-termist capital markets.

The trouble with this is that it does not persuade hard-nosed economists, who point out that outside a few special areas - possibly very small business, possibly hi-tech firms - it is impossible to find any evidence that companies cannot get the funds they need to invest. There is no greater shortage of capital available to finance investment projects in the UK or US than anywhere else. British businesses actually finance a bit less of their investment from retained earnings than businesses on the Continent.

Of course, businessmen are normally very happy to pin the blame for underinvestment on short-termism in the City. But the IPPR's recent business commission displayed its independence from partisan Labour views by blaming short- termism in business instead. Its report* says: "There is much evidence that both in their investment decisions and in their approach to building relationships too many British companies are short-termist." Rubbing salt into the wound, it adds, in a section headed "UK company myopia": "The culture and attitudes of managers in some industrial and commercial firms are quite congenial to a short-term, deal-making approach."

Getting to the bottom of the problem demands a dissection of the evidence first of all. The Eeyore tendency claims that Britain's investment performance has been particularly disappointing during this recovery compared with previous recoveries at the same stage.

The claim needs a health warning. The soggier performance mainly reflects the housing market slump and declining investment by the privatised gas, electricity and water companies following a privatisation-related surge in earlier years. In addition public sector investment has fallen sharply.

Non-residential investment by private business has grown at a reasonably healthy pace although not, as the chart shows, reaching its late-1980s heights. Within this category, manufacturing investment has been weak but investment by services - more than twice the size - has been strong.

Health warning posted, why should British business be especially short- termist in its investment decisions? Surveys which ask companies to list the biggest obstacles to new investment regularly blame uncertainty about demand. The IPPR's business commission notes that the UK's tendency to run its economy via boom and bust plays a role here. For example, the inflation rate has been one of the highest and most variable in the OECD since 1980, and growth has been similarly volatile. This is partly because policy-making is overactive - for example, if the Chancellor could reduce taxes in the past two Budgets, why did they have to go up so much in the previous two Budgets?

According to Ciaran Driver, an economist at Imperial College, London, there is evidence that companies think the business environment has become more uncertain since 1980 because there is a higher risk premium in the return they demand from investment projects. This is another way of saying the hurdle rate of return on investment is so high because companies want a higher reward for taking a greater risk.

Evidence for the increased perception of risk, he argues**, can be found in answers to a question in the CBI's industrial trends survey. The proportion reporting that their investment was restricted by inadequate expected returns has trended strongly upwards during a period when the actual rate of return was also increasing strongly. The pre-tax rate of return for industrial and commercial companies as a whole more than doubled, to 8.3 per cent, between 1980 and 1993. The logical conclusion is that other forces had raised the required rate of return. It could have been a rising cost of capital, but the survey contains this as a separate question. That leaves a higher risk premium as the most likely explanation.

This still leaves the question as to why the risk premium for investment has risen, and why it is higher in the UK than elsewhere. There have been extraordinary swings in policy fashion since 1980, it is true - hard-line monetarism, then pragmatic monetarism, then membership of the ERM, inflation targeting following the UK's undignified exit from the ERM, and possibly now a return to an exchange rate target. But it has to be said that policy was overactive before 1980 too.

British businesses face current uncertainties not shared by most of the European and US counterparts, in not knowing whether or not the country will join the European single currency on the one hand, or perhaps leave the EU altogether. But this is a pretty recent risk.

Dan Corry, an economist at the IPPR, says: "It is a more tenable explanation for low investment than many others, but it is hard to understand why risk would affect Anglo-Saxons more than others." Without that understanding, it is equally hard to be dogmatic about recommending public policies to tackle the investment problem, if it is a problem.

The IPPR commission recommends levelling the tax playing field between dividends and retained earnings and, more vaguely, changing the legal and tax framework to encourage managers to take a longer-term view. Worthy stuff, but if this is the sum result of their collective wisdom, you have to begin to wonder whether there is an underinvestment "problem" at all.

* Promoting Prosperity: A Business Agenda for Britain, IPPR, pounds 8.99.

** Chapter 4 in "Creating Industrial Capacity", ed J Michie and J Grieve Smith, OUP 1996.

Suggested Topics
Start your day with The Independent, sign up for daily news emails
News
Bobbi Kristina Brown with her mother Whitney Houston in 2011
people
News
The actress Geraldine McEwan was perhaps best known for playing Agatha Christie's detective, Miss Marple (Rex)
peopleShe won a Bafta in 1991 for her role in Oranges Are Not The Only Fruit
News
The guide, since withdrawn, used illustrations and text to help people understand the court process (Getty)
Ministry of Justice gets law 'terribly wrong' in its guide to courts
News
Starting the day with a three-egg omelette could make people more charitable, according to new research
scienceFeed someone a big omelette, and they may give twice as much, thanks to a compound in the eggs
PROMOTED VIDEO
News
newsPatrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad
News
Robert Fraser, aka Groovy Bob
peopleA new show honours Robert Fraser, one of the era's forgotten players
Life and Style
Torsten Sherwood's Noook is a simple construction toy for creating mini-architecture
tech
News
Top Gun actor Val Kilmer lost his small claims court battle in Van Nuys with the landlord of his Malibu mansion to get back his deposit after wallpapering over the kitchen cabinets
people
Sport
David Silva celebrates with Sergio Aguero after equalising against Chelsea
footballChelsea 1 Manchester City 1
News
i100
ebooks
ebooksA special investigation by Andy McSmith
News
peopleHere's what Stephen Fry would say
Arts and Entertainment
tv
News
Richard Dawkins is known for his outspoken views
people
Life and Style
L’Auberge du pont de Collonges (AFP)
food + drinkFury at British best restaurants survey sees French magazine produce a rival list
Arts and Entertainment
Bourne's New Adventures dance company worked with 27 young Londoners to devise a curtain-raiser staged before New Adventures' performance of Edward Scissorhands
theatreStar choreographer Matthew Bourne gives young carers a chance to perform at Sadler's Wells
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Software Development Manager

£40000 - £50000 per annum: Recruitment Genius: This is an exciting opportunity...

Ashdown Group: Product Manager - (Product Marketing, Financial Services)

£30000 - £35000 per annum + Benefits: Ashdown Group: Marketing Manager - Marke...

Recruitment Genius: Compliance Assistant

£13000 per annum: Recruitment Genius: This Pension Specialist was established ...

Ashdown Group: Market Research Executive

£23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...

Day In a Page

As in 1942, Germany must show restraint over Greece

As in 1942, Germany must show restraint over Greece

Mussolini tried to warn his ally of the danger of bringing the country to its knees. So should we, says Patrick Cockburn
Britain's widening poverty gap should be causing outrage at the start of the election campaign

The short stroll that should be our walk of shame

Courting the global elite has failed to benefit Britain, as the vast disparity in wealth on display in the capital shows
Homeless Veterans appeal: The rise of the working poor: when having a job cannot prevent poverty

Homeless Veterans appeal

The rise of the working poor: when having a job cannot prevent poverty
Prince Charles the saviour of the nation? A new book highlights concerns about how political he will be when he eventually becomes king

Prince Charles the saviour of the nation?

A new book highlights concerns about how political he will be when he eventually becomes king
How books can defeat Isis: Patrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad

How books can defeat Isis

Patrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad
Judith Hackitt: The myths of elf 'n' safety

Judith Hackitt: The myths of elf 'n' safety

She may be in charge of minimising our risks of injury, but the chair of the Health and Safety Executive still wants children to be able to hurt themselves
The open loathing between Barack Obama and Benjamin Netanyahu just got worse

The open loathing between Obama and Netanyahu just got worse

The Israeli PM's relationship with the Obama has always been chilly, but going over the President's head on Iran will do him no favours, says Rupert Cornwell
French chefs get 'le huff' as nation slips down global cuisine rankings

French chefs get 'le huff' as nation slips down global cuisine rankings

Fury at British best restaurants survey sees French magazine produce a rival list
Star choreographer Matthew Bourne gives young carers a chance to perform at Sadler's Wells

Young carers to make dance debut

What happened when superstar choreographer Matthew Bourne encouraged 27 teenage carers to think about themselves for once?
Design Council's 70th anniversary: Four of the most intriguing prototypes from Ones to Watch

Design Council's 70th anniversary

Four of the most intriguing prototypes from Ones to Watch
Dame Harriet Walter: The actress on learning what it is to age, plastic surgery, and her unease at being honoured by the establishment

Dame Harriet Walter interview

The actress on learning what it is to age, plastic surgery, and her unease at being honoured by the establishment
Art should not be a slave to the ideas driving it

Art should not be a slave to the ideas driving it

Critics of Tom Stoppard's new play seem to agree that cerebral can never trump character, says DJ Taylor
Bill Granger recipes: Our chef's winter salads will make you feel energised through February

Bill Granger's winter salads

Salads aren't just a bit on the side, says our chef - their crunch, colour and natural goodness are perfect for a midwinter pick-me-up
England vs Wales: Cool head George Ford ready to put out dragon fire

George Ford: Cool head ready to put out dragon fire

No 10’s calmness under pressure will be key for England in Cardiff
Michael Calvin: Time for Old Firm to put aside bigotry and forge new links

Michael Calvin's Last Word

Time for Old Firm to put aside bigotry and forge new links