24 November 2015

Forbes: Britain, investment, and Brexit

The UK General Election this year set out in stark terms the economic challenges facing Britain that have yet to be addressed: key among them are the productivity puzzle and the prospect of Brexit, which both relate to the challenge of low investment.

Britain’s low productivity growth since the 2008 recession has been described as “historic” by the Office for National Statistics. While output per hour in the rest of the G7 has recovered and now exceeds pre-crisis levels, Britain’s productivity remains below. Looking across the G7, Britain is around 17% less productive than the U.S., Germany and France, and only exceeds Japan.

It is certainly the case that unemployment hasn’t risen by as much during this recession than the loss in output implied. [...]

But, there is one key difference between the U.S. and the U.K. Most of the financing in America comes from capital markets, while Britain, like the rest of Europe, relies predominantly on bank lending. So, while the banks rebuild their balance sheets and lending falls, investment in Britain suffers. Plus, public investment was cut back dramatically as part of the austerity package to reduce the fiscal deficit and low demand likely deterred private investment even by those larger companies with cash to do so.

This was essentially the conclusion of the Bank of England when it looked into the productivity puzzle. Without investment, workers will find it hard to produce more output. And if workers don’t increase their output, then it’s difficult to raise wages on a sustainable basis and therefore incomes.

Above-inflation price increases for much of the past seven years have also reduced real wages and contributed to stagnant incomes for much of Britain. The latest ONS survey found that household incomes are still below pre-crisis levels and about the same as a decade ago. It’s not just due to the need for household consumption to boost economic growth. Improving standards of living is key to long-term prosperity. And this comes down to raising incomes, wages and therefore solving the productivity puzzle. [...]

The second big economic challenge may not have had a big impact thus far on firms’ willingness to invest, but could in the future. And, Brexit won’t be resolved for a while yet.

The in/out decision in the EU referendum may take place earlier and by 2017. That uncertainty ranks higher in the investment and strategic decisions of companies than Grexit or the prospect of Greece leaving the euro zone in many surveys.

Markets dislike uncertainty and some firms may even put off investment and decisions around the location of their headquarters until Brexit is resolved. That won’t help raise investment in the short term.

But, the longer term challenge is there regardless in one sense. As the euro zone builds institutions to support the single currency which could take decades, there will be implications for the non-euro EU countries like the U.K. That’s an uncertainty that will linger for far longer, and it’s unlikely to be resolved through Britain’s Brexit negotiations. So, even as the EU referendum marks the end of one set of uncertainty, the bigger question of the relationship between euro and non-euro countries will likely remain for years to come. Policy making within such a context will be more challenging than before, but essential to foster confidence, investment, and therefore growth.

Full article on Forbes

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