When TS Eliot wrote: “Time present and time past are both perhaps present in time future,” he didn’t have business investment in mind. But the opening lines of his poem “Burnt Norton” capture why this component of the economy, which makes up a tenth of GDP in Britain, matters. When firms invest in plant, equipment and vehicles, improve computer systems and carry out research and development, such spending both contributes to GDP today and expands future capacity, including for innovative products and services. That’s why persistently low and now acutely weak business investment is a cause for concern.
During the second quarter of 2020, broadly corresponding with the first lockdown, GDP shrank by 18.8 per cent. Vertiginous a fall though that was, business investment dropped even more steeply, by 25.4 per cent. In the subsequent three months as restrictions were lifted, GDP snapped back by 16 per cent. Business investment also recovered, but by what was in comparison a less impressive 9.4 per cent.
The overall contrast between the path for the economy as a whole and that for investment by businesses is stark. Even though the summer recovery was so vigorous, GDP in the third quarter was still 8.6 per cent lower than before the pandemic, at the end of 2019. But business investment was 19 per cent down. To put that in perspective, its fall in 2009 following the worst financial crisis since the early 1930s was 15.3 per cent.
Full figures are not available yet for the final quarter of the year, which was affected by the re-imposition of restrictions, including the second lockdown in November. However, that divergence between GDP and business investment is unlikely to have changed much in the past three months. Now a third lockdown is under way, and is likely to persist for much of the first quarter of the year. Once again business investment looks set to suffer badly. In early December, a panel of chief financial officers polled in a Bank of England survey was already gloomy about the impact of the epidemic on their investment plans in the first three months of 2021.
Making matters worse, the slump in business investment comes after three years of stagnation in the wake of the Brexit referendum in June 2016. Earlier in the last decade it grew at a healthy rate, as firms sought to make up for the cuts they had made in 2009. In the seven ensuing years, 2010-16, business investment grew at an annual rate of 5.2 per cent. But in 2017 growth slowed to 1.5 per cent, an extremely disappointing rate given that this was the strongest year for the global economy and world trade since 2011. In 2018, when international conditions (though deteriorating) were still quite favourable, business investment actually fell by 2.5 per cent. It then grew by just 1.1 per cent in 2019.
Uncertainty has played a crucial role in all this. It was only three weeks ago that businesses learned what the actual terms of the new commercial relationship would be with the EU, Britain’s largest trading partner. Firms responded like drivers in a fog, putting capital projects on hold or cancelling them. Findings from the Bank of England’s panel have shown that the more uncertain companies have been about Brexit, the more they have curbed investment since the referendum. The uncertainty arising from Covid-19 has been less protracted but even more severe.
But the weakness in business investment can’t be blamed solely on uncertainty. It was quite rational for many firms (such as car manufacturers) to cut back on capital spending in Britain after the vote to leave the EU. Whatever the precise nature of the new trading relationship, it was bound to be worse than the position Britain already enjoyed. Government economic analysis in November 2018 showed that a trade deal similar to the one finally reached would bring about a long-term loss of 4.9 per cent of GDP compared with staying in the EU, even taking into account the (very modest) gains from striking new trade deals with countries outside the EU.
Similarly, Covid-19 looks set to inflict a lasting dent on the economy. If the vaccination programme works as effectively as is hoped, there will be a sustainable recovery. But even when the economy has bounced back and reverted to its previous growth path, it is likely to remain smaller than if the pandemic hadn’t occurred. In its central forecast in November, the Office for Budget Responsibility reckoned that there would be an enduring shortfall of three per cent of GDP.
Whatever the precise sources of weak business investment, the consequences are undesirable. Productivity growth is the mainspring of economic growth. By cutting back on capital spending, firms are removing one of the main ways in which productivity increases. Whatever happens to demand in the years ahead, the capacity to meet it will be less than if businesses had felt confident enough to invest more now.
In “Burnt Norton,” Eliot goes on to speculate that time future is “contained” in time past. The dearth of business investment over the past few years already casts a shadow over Britain’s economic future.