The coronavirus crisis is a new type of recession, but all the normal reasons why business investment recovers slowly from downturns still apply and the uncertainty about Brexit is an additional drag. The upshot is that business investment will lag behind the recovery in the rest of the economy.
- The coronavirus crisis is a new type of recession, but all the normal reasons why business investment recovers slowly from downturns still apply and the uncertainty about Brexit is an additional drag. The upshot is that business investment will lag behind the recovery in the rest of the economy.
- The direct impact of social distancing on large parts of consumer spending means that, unusually, in this recession consumer spending has probably fallen further than business investment. Thereafter, however, we think business investment will recover more slowly than any other part of the economy. (See Chart 1.)
- Business investment always struggles in the aftermath of recessions. (See Chart 2.) Admittedly, changes to the economy accelerated by the coronavirus could lead to higher investment in some areas, such as ICT to enable more remote working. But there are four reasons why overall business investment and investment in transport and machinery will remain subdued for longer than other parts of the economy.
- First, many firms will not need to invest. Business investment has a good relationship with capacity utilisation because firms tend to invest when they need to expand capacity to meet the demand for their products. Our view that there will be a large amount of spare capacity in the economy for several years means that most firms will not need to invest anytime soon. (See here.)
- Second, the collapse in earnings will push investment firmly to the back of the minds of CEOs. There is a good relationship between firms’ net rate of return and investment. With profits likely to be sharply reduced, most firms will not have the money to fund investment.
- Third, even once earnings recover, many businesses will be saddled by debt. Firms borrowed £56bn from banks between March and May, increasing the stock of outstanding loans by over 10%. This will keep businesses afloat, thereby ensuring that the supply capacity of the economy is not depleted. But it will also make firms more risk averse and prompt them to focus on repaying debt rather than investment. (See here.)
- Fourth, extremely high uncertainty is likely to mean that firms don’t want to invest. The speed of the recovery from the virus and what permanent changes there will be to working practices are both unknown. Brexit is an extra source of uncertainty that other economies don’t have. Our assumption is that a deal for trade in goods will be agreed by the end of the year and that the status quo is maintained for trade in services until a later date. But even in this relatively benign scenario, the substantial chance of a “no deal” means that firms will be reluctant to invest, as has been the case since the referendum in 2016. (See here.)
- The result of all this has been a sudden shelving of investment plans. The investment intentions balances of the Bank of England Agents’, CBI and BCC surveys have fallen to record lows. Since many investment projects take years to plan, the empty pipeline will mean investment is low for a sustained period.
- Our forecast is that after falling by 25%, business investment will only recoup the lost ground slowly and still be 8% below its pre-coronavirus level by the end of 2021. Thereafter, based on our assumption that Brexit uncertainty is removed and monetary policy remains very loose, the recovery in business investment will gather more momentum. So while weak investment will be a brake on growth in the near term, it will eventually recover and therefore shouldn’t reduce the economy’s long-run potential growth rate.
Chart 1: GDP by Expenditure (Q4 2019 = 100)
Chart 2: GDP & Business Investment (Q4 2019 = 100)
Sources: Refinitiv, Capital Economics
Sources: Refinitiv, Capital Economics
Andrew Wishart, UK Economist, +44 7427 682 411, firstname.lastname@example.org