PRIVATE firms are increasingly flush with cash. Profit margins globally are at record highs, and UK firms have been busy paying down debts and building financial reserves. So why are we not seeing an investment boom? As the Ernst and Young Item Club said this weekend, business investment rose by a miserable 1.2 per cent last year, even though UK Plc is sitting on a corporate cash pile now worth £754bn, equivalent to half of GDP.
So what is going on? In the case of banks, of course, retained earnings are being ploughed into extra capital. But the situation in the rest of the private sector is ominous: the money is being used to invest abroad, including in emerging markets, rather than in the UK. And given that the British economy is hardly becoming any more competitive, that is unlikely to change any time soon.
First, the facts. The corporate sector has indeed been generating vast amounts of cash – though this started in 2002. Over the past four years, the financial surpluses of non-financial firms – the corporate equivalent of the savings rate – have averaged a hefty 3.1 per cent of GDP. As research from Citigroup’s Michael Saunders reveals, there used to be a close relationship between the size of the surpluses generated by UK firms and how much cash they would hold in sterling bank accounts. Quite simply, the better they did, the more money they put in UK bank accounts, readying themselves to spend it on new offices and factories in Britain. The worse they did, the more they dug into their reserves and borrowed. Eventually, large corporate surpluses were reflected in a sharp improvement in companies’ sterling balance sheets — a rapid drop in debts and build-up of cash holdings — and eventually an investment boom in the UK.
Sadly for Britain’s feeble economy – the Item Club says it will grow just 0.4 per cent this year – this relationship no longer holds. Over 2002-11, the UK corporate sector’s financial surplus hit £367bn. But during the same time, UK companies’ sterling deposits at UK banks went up by just £98bn. Their net sterling assets at UK banks actually went down by £95bn as they also borrowed an extra £193bn. So what happened to the money? It all went abroad: foreign companies were taken over and huge direct investments made. The result was net purchases of foreign equities worth £443bn over 2002-11. UK firms also increasingly keep their money in foreign currencies: their net assets at foreign banks surged (deposits up £314bn, debts up £119bn, hence a £194bn net rise in financial assets).
So firms are spending and distributing less than they are making in the UK; and the billions generated are being pumped abroad, either directly into companies or as a stepping stone into foreign bank accounts. Saunders describes the UK corporate sector as merely a “cash cow” to fund the overseas expansion of global multinationals. He’s right: those hoping that UK firms will soon start to spend their cash are too late. They have already been spending, just not on UK assets.
Relative rates of return are too low and risk too high in the UK. That is why it is so urgent to make the UK attractive again for investment: the chancellor is right to be cutting corporation tax – but he has failed to deliver elsewhere, including on planning reforms. Our only hope is to make the UK a more attractive place for global firms to invest in, a place where the risk-adjusted return on their capital becomes worthwhile again. The sorry truth is that until we get a real supply-side revolution, private investment and hence economic growth and job creation will remain one long, bitter disappointment.
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