Strategy & economics
Remember that thing called investment?
It was not just that the UK grew appreciably faster in 2013 than had been widely predicted at the start of the year; it was more that the components of growth began to suggest the UK economy was entering a new phase. The headline was that household spending made the biggest contribution to the increase in activity during the year. It accounted for 1.5% of the 1.8% gain in total GDP. Other contributions were fairly minor – 0.2% from government spending, -0.1% from fixed capital investment, 0.3% from inventories and 0.1% from trade (the traditional statistical discrepancy means that the contributions from demand components of GDP do not sum to the growth rate itself). At a glance, this does not seem to support my assertion that we may be about to embark on a new stage of the recovery, but the annual contributions hide an important trend in one crucial area: capital spending.
According to the statisticians, the final quarter of 2012 saw a collapse in business’s spending on machinery and equipment, which contributed to an overall decline of 4.5% in capital investment (and a 7.8% decline in business investment, itself), when compared to the previous quarter. I admit to being not a little suspicious of this reported slump in spending, although the previous two quarters were also weak. In purely statistical terms, the falling trend in spending meant that investment coming into 2013 started from a very low base. This made it very difficult for there to be any positive contribution from investment during 2013 as a whole when compared with 2012. But the quarterly trend last year paints a different picture, with consecutive quarter-on-quarter increases of 0.5%, 3.9%, 1.7% and 2.4%. Thus, in the fourth quarter, investment spending was some 8.7% up compared to a year earlier; this is a rather nice mirror image of the first quarter when it was 8.7% down on the level in the same quarter of 2012. What is more, if we look at the year-on-year growth rate of 2.7% in fourth quarter GDP, 1.2% is accounted for by the rebound in capital spending, with 1.5% being attributable to household spending.
So, while it remains true that capital investment in 2013 was 0.5% lower than in 2012, this hides the real story, which is that by the year end there had already been a very marked turnaround. I believe it is this feature of the economy that could prove crucial over the next few years.
Alongside the previous weakness in capital spending had been a dire trend in productivity and, conversely, very buoyant employment numbers. Whereas economists have been writing about the employment conundrum, I think it makes perfect sense that companies have been employing more people when investment spending has been so weak. All other things being equal, you would have expected the UK to have supported its recent growth through productivity gains and, therefore, with no noticeable impact on employment. But other things have not been equal. Against a backdrop in which there will have been significant retirement of capital, companies have had to take on more people even to support modest growth. This is not a conundrum; it is merely the consequence of companies lacking the confidence to undertake longer-term investment programmes.
If, as the latest national accounts data implies, we are now at the start of a reasonably strong upturn in capital spending, we can expect a greater proportion of total growth in the economy to be supported by productivity gains. At the same time, unless GDP races ahead, further gains in employment are likely to be comparatively modest. But this is not something that we should worry about; productivity is unequivocally a good thing. Indeed, it is at the top of the list of good things. Once output per person begins to grow more rapidly, companies will see profit margins start to improve and the employed labour force will begin to see per capita incomes rise in real terms. Generating sustainable growth in demand, this then becomes a positive feedback loop. The icing on the cake, of course, would be a similar improvement in the UK’s trade position, based on a rebound in export growth. While this may have to wait another year or so to emerge fully, it would finally mark a successful rebalancing of the UK economy.
This article is issued by Cazenove Capital Management which is a trading name of Schroder & Co. Limited, 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Issued in the Channel Islands by Cazenove Capital Management which is a trading name of Schroders (C.I.) Limited, licensed and regulated by the Guernsey Financial Services Commission for banking and investment business; and regulated by the Jersey Financial Services Commission. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital Management unless otherwise stated.