Strong case for optimism says EY economist

Record investment as firms take advantage of lower costs

scottish industryBusiness investment has made up the ground lost since the recession and is now at its highest since 2000, according to the EY Item Club.

Companies are taking advantage of cuts in corporation tax, low borrowing costs, easier access to finance and cheaper energy.

Investment reached 11% of GDP in Q2 2015, the highest level since the end of 2000 and is expected to rise by an average of 6.4% a year from 2015 to 2019, when it is expected to reach a record high of 12.9% of GDP.

Martin Beck, senior economic advisor to the ITEM Club, said: “UK business investment has performed impressively in recent years, substantially outgrowing other components of GDP since 2010.

“And there are strong reasons to be optimistic about prospects for investment over the next few years. A continued appetite among firms to invest will be good news for productivity growth, and will ensure that the expansion of the UK’s economy is sustainable.”

The ITEM Club report adds that since 2008, the price of capital relative to labour has moved heavily in favour of the latter, reflecting historically weak pay growth. But the ongoing recovery in pay combined with the introduction of the ‘living wage’ next year should spur firms to invest more in labour-saving technology and improving efficiency.

Mark Gregory, chief economist at EY, adds: “Changes in work practices, such as the rise of self-employment and home working, mean that the already strong headline figures probably understate the true levels of business investment.

“With around 15% of the workforce now working for themselves, a lot of items bought for personal use, such as laptops and smartphones, are also used for business purposes. In the national accounts, this will boost retail sales but not investment, even though the purpose of this spending may be as much for production as consumption.”

Outlook for business investment is not uniformly bright

Despite plenty of reasons to think that business investment is set to continue to make a substantial contribution to UK growth, the ITEM Club says that these positive forces will have to battle potential headwinds.

The shrinking North Sea sector, is one likely drag on investment growth. With the extraction sector representing 7% of total business investment, the Club concludes that a drop in investment by oil and gas companies will have a disproportionate effect on capital spending by firms.

In addition, companies will be under pressure to use some of the extra cash on their balance sheets to service hefty corporate pension deficits, diverting resources away from investment as a result. Finally, uncertainty over the outcome of the referendum on the UK’s membership of the EU may affect investment levels in those sectors exposed to exporting to the EU.

Mr Beck concludes: “Overall, the balance of forces working for and against continued strong growth in business investment are erring towards the former. Business investment should continue to rise well in excess of overall GDP growth, implying that secular stagnation is an affliction that the UK should happily avoid.”

Bank of Scotland monitor

The latest Business Monitor from Bank of Scotland shows the Scottish economy continuing to recover from the slowdown experienced at the start of the year. New business levels have picked up strongly this summer. Expectations for the next six months continue to signal moderate growth for the remainder of 2015.

Donald MacRae, chief economist, Bank of Scotland said: “The Scottish economy slowed at the start of 2015 but is expected to return to moderate growth in summer and autumn. Expectations remain positive and suggest that current growth rates will be maintained in the third quarter of the year.”

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