THIS is the week Britain will finally exit its double-dip recession – or at least, so we must all hope. Barring the most extraordinary upset in the history of British economic forecasting, figures out on Thursday will show that the economy grew at least a little during the third quarter, making up some of the ground lost during the Jubilee bank holiday. We may even be told what the authorities believe was the impact of the Olympics.
The return to growth will be a boost to morale. The problem, of course, is what next. Companies are still reluctant to spend, and with good reason given Britain’s many problems, the abysmal Eurozone outlook, the US fiscal cliff and extreme political uncertainty around the world. Take one of our front page stories today. Companies have increased their dividends by 10.4 per cent over the past year, with payouts reaching a record £23.3bn in the third quarter, according to Capita. That is excellent news for shareholders: the returns from buying equities come overwhelmingly from reinvested dividends, not capital gains. Improved dividends will boost investors’ wealth and hence their spending. Higher returns will also make providing capital more attractive, and increase the demand for equities, a good thing over time.
But in the short term the higher dividends are a symptom of corporates that aren’t keen to invest in the UK. Rather than using the money to hire more staff, add new offices or chase more customers, they are returning it to their providers of capital, with the implicit message that their internal rate of return isn’t as good as what the shareholders could achieve elsewhere. That is a deeply depressing and defeatist message.
Some of the cash being generated by UK firms is being used to pay down debt: the debt/GDP ratio for the non-financial corporate sector has edged down from 120.6 per cent in the fourth quarter of 2008 to 109.7 per cent in the second quarter of this year. However, this remains too high for comfort from a long-term perspective: it was just 58 per cent of GDP in 1997. So more of the extra cash being generated by UK Plc is bound to go into paying down corporate debt over the years to come, acting as a further drag to investment. Another issue is pension funds, which have needed massive topping up.
But there is an even bigger issue. In the five years to the end of June, the UK corporate sector’s aggregate financial surplus – retained profits minus investment, interest, dividends, tax and the like – hit £256bn. Very little of this money has ended up sitting in deposits at UK banks – just £8bn, in fact, which means that those waiting for a massive spending spree are about to be bitterly disappointed.
A detailed analysis by Michael Saunders of Citigroup shows that the bulk of the money – apart from some debt reduction and a drop in net UK equity liabilities – went abroad. There was a £37bn rise in non-sterling bank deposits and deposits at overseas banks, plus £253bn in net foreign direct investment and purchases of foreign equity. British firms are making money in the UK – and then shipping it out of the country to faster growing, more profitable markets.
There is only one solution: the UK needs to be made dramatically more attractive and competitive, a place where companies actually want to allocate their capital. We need a supply-side revolution to ensure that every extra pound invested here can be expected to yield a competitive return. If this doesn’t happen, the UK will remain a stagnant cash cow, there to be milked to finance more exciting spending in the rest of the world. We have been warned.
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