4 minute read 28 Jun 2021
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Why the UK is set for a post-COVID-19 rebound in business investment

By Peter Arnold

UK&I Partner, Economic Advisory, Ernst & Young LLP

A passionate leader and trusted advisor. Over 20 years of experience in economic policy, regulation and competition. Optimising client strategies through the use of analytics and economic analysis.

4 minute read 28 Jun 2021
Related topics COVID-19 Growth Workforce Finance

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

In brief
  • EY ITEM Club believes the balance of economic forces following the pandemic points to a strong recovery in UK business investment over the coming years.
  • It expects business investment to grow by just over 7% in 2021, matching its pre-COVID-19 level by the end of this year, and then by more than 10% in 2022.
  • However, the pace of the recovery in business investment will depend on firms having confidence in the strength of demand in the economy.

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.

Business investment fell by

10.2%

In 2020 – slightly more than the decline in GDP of 9.8%

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.

Financial resources and incentive to invest will be key to the recovery

While the conditions are in place for a recovery in business investment, the strength of that recovery will depend – at least in part – on what resources firms can use to finance investment, and the incentive to plough those resources into capital equipment. Companies coming out of the crisis with higher levels of debt will see interest costs eat up more revenue and may have less capacity to borrow in the future. Both of these factors might impact investment.

More positively, the burden of corporate debt in comparison to GDP ended 2020 still below its pre-financial crisis peak. Additionally, as spending on wages and other expenses fell during the pandemic, and revenues were shielded by government aid, the corporate sector accumulated over £100bn of ‘excess’ cash. Just as individuals drawing on their savings could fuel a strong revival in consumer spending, so firms’ increased cash holdings offer the hope of a robust upturn in investment.

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. 

The banking sector entered the pandemic well-capitalised and funding has been readily available to support businesses and households. The economic effects of the pandemic have also been felt most in less capital-intensive sectors, like hospitality.
Peter Arnold
UK&I Partner, Economic Advisory, Ernst & Young LLP

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.

Summary

While business investment in the UK has fallen behind other major economies for many years, there are now clear reasons for believing that the pandemic may have created conditions for a sustained rebound. However, the factors in favour of higher investment by UK firms are balanced by negative influences, including natural caution following repeated economic shocks. Ultimately, a sustainably higher level of business investment will require maintaining high economic confidence – and while this appears likely to emerge, it by no means remains certain that it will happen.

About this article

By Peter Arnold

UK&I Partner, Economic Advisory, Ernst & Young LLP

A passionate leader and trusted advisor. Over 20 years of experience in economic policy, regulation and competition. Optimising client strategies through the use of analytics and economic analysis.

Related topics COVID-19 Growth Workforce Finance