Why the UK is set for a post-COVID-19 rebound in business investment

EY ITEM Club has analysed the outlook for investment by UK businesses – and believes firms’ economic confidence will be the deciding factor.

As the COVID-19 pandemic subsides and the UK economy reopens, questions are emerging around how to ensure a sustainable recovery and resolve some long-standing economic issues – notably weak growth in productivity. The outlook for business investment is key to answering those questions.  

Over the past decade or so, business investment in the UK has experienced a ‘triple whammy’ consisting of the global financial crisis, uncertainty surrounding Brexit and the COVID-19 pandemic. Growth in spending on fixed assets like machinery and IT equipment was especially slow in the five years running up to the pandemic. And UK firms have consistently invested less than their peers in other major economies. 

Several factors have mitigated the pandemic’s impact on business investment

But there are positive signs. While business investment fell by 10.2% in 2020, the fall was smaller than 2009’s record 15.3% decline. A bigger reverse was averted by the fact that the pandemic did not trigger the freezing of bank lending that characterised the global financial crisis, and that the economic pain was concentrated in less capital-intensive sectors. Meanwhile, COVID-19-related shifts in demand meant that investment in some sectors actually grew during 2020.

Consumer spending is likely to take the lead in the near future in bringing the economy back to its pre-pandemic position. Where consumption leads, investment should follow, as firms respond to stronger demand and rising confidence. It’s no coincidence that surveys of investment intentions have picked up significantly in the last few months.

There will be significant variations between industries

Whatever the overall pace of the post-pandemic rebound, the impacts of COVID-19 on business investment will vary by sector. With many companies intending to make increased homeworking permanent, spending on IT and communications equipment could be boosted. The continuation of some social distancing measures may encourage investment in automation. And if the pandemic and Brexit reduce the number of overseas workers, employers might invest more in labour-saving technology. Conversely, if homeworking becomes a fact of life for more people, investment in commercial real estate could be permanently affected. 

New tax breaks will have a positive effect – but with limitations

The temporary 'super-deduction' tax incentive announced by the Chancellor in his March Budget should help to increase investment spending by making more projects profitable and providing companies with a strong incentive to bring spending forward. But the super-deduction’s effect will be time-limited, and its coverage is restricted to a small subset of investment. The incentive effect for small firms will also be less powerful than for large companies. Additionally, the planned rise in the corporate tax rate in April 2023 presents a medium-term headwind to business investment. 

Levels of economic optimism and confidence in rising demand will be the deciding factors

What emerges clearly from recent history is the importance of demand in the economy in influencing investment. Given the slower pace of GDP growth in the decade to 2019, it’s unsurprising that firms adapted by investing less than they might otherwise have done. The pessimistic view is that after experiencing a long period of weak economic growth and two major global economic shocks in little more than a decade, companies are likely to remain reluctant to invest, even if the economy enjoys a post-COVID-19 spurt.          

But there’s also an optimistic angle. The high household savings ratio could provide fuel for a consumer boom, which will benefit from the Government moving away from the austerity programmes of previous administrations. At the same, time, the Government is committed to ‘levelling-up’ to narrow regional disparities, while the Bank of England is likely to proceed slowly in raising interest rates. Together, these factors create the potential over the next few years for a ‘higher-pressure’ economy than the UK has experienced for some time, which could in turn boost business optimism and investment. The million-dollar question? Whether that optimism can be sustained long enough for firms to reset their expectations and factor in a more promising future, instead of being bound by the experience of a decade of disappointment.