UK economy sees improvement – but long-term problems remain
Last week, we released our second annual ‘State of UK Business’ report . It is a broad and comprehensive survey of over 1,500 UK business leaders, which digs into exactly how the UK’s most senior business leaders are feeling and what their businesses are planning.??
The results reinforced my view – which I set out in the previous newsletter – that the UK economy may prove more resilient this year and that inflation, and therefore interest rates, may not come down (or stay down) to the extent people are expecting.??
Economy looking more resilient – but there are implications for inflation and interest rates?
The survey revealed a marked increase in expectations for economic growth and consumer confidence, as well as wider metrics of economic strength compared to last year. Even amid cost-of-living pressures, 60% of leaders think customers will buy more products or services from their businesses this year. Only 21% expect customers to switch to less expensive products or services.?
This looks to have an impact on business leaders’ workforce and pricing plans. Nearly three-quarters (73%) of businesses expect to maintain or increase their headcount in 2024. Over one-third (38%) said hiring was neither more nor less difficult than last year. Interestingly, nearly as many business leaders said it was easier (28%) as said it was harder (25%) to hire staff than last year.??
All of this is surprising, given the prevailing narrative that unemployment will rise sharply this year and the hiring landscape has become much easier compared to 2023. Maybe someone forgot to actually ask businesses? I’m also inclined to trust our survey over forecasts when it comes to the labour market picture (not least due to the many data challenges with the Labour Force Survey). Looking back to last year, we were essentially in the same position. Most economic forecasts suggested unemployment would rise quickly, but our survey showed three-quarters of business leaders planned to maintain or grow headcount. In the end, the latest stats show that unemployment barely moved last year.??
But the most interesting findings are around pricing plans. Over three-quarters (77%) of business leaders expect to raise prices in 2024 – with over half (52%) saying they will do so by a whopping 6% or more, and 22% by 10% or more. If those in the Bank of England are reading this, I apologise for the minor cardiac arrest you may have just suffered. It’s pretty astonishing that business leaders are so bullish on plans to increase prices.??
Why is this? We can piece together some sense from our survey data. It’s partly due to the continued strong labour market – businesses clearly expect wage pressures to persist. Another part is likely down to the continued high cost of doing business. We saw continued concerns around energy prices in our survey. This has largely dropped out of the wider narrative, with the focus shifting to interest rates, but clearly business leaders are still feeling the pinch – not least since electricity prices are still twice what they were a few years ago. Finally, we see a confluence of both businesses which are struggling and those which are doing very well and wanting to push through price rises. Those who saw margins squeezed last year believe they will raise prices just to survive, while those that managed to improve margins believe they have the pricing power to continue to raise prices.??
The question now is not whether inflation gets back towards the 2% target – it likely will, due to base effects (the fact that the sharp rises in energy price cap last year will fall out of the annual calculation) – but whether it stays there. Even the Bank of England’s latest forecast sees inflation rising again later this year. But given our survey results, I can’t help but feel they may be underestimating the persistence. Demand looks set to be stronger while supply, especially in the form of a tight labour market, will continue to be constrained.??
Our survey isn’t the only data pointing in this direction. Recent Purchasing Managers Index (PMI) surveys show UK businesses are in expansion territory – particularly in services and, to an extent, in construction, both of which are key to the UK economy.?
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Long-term picture remains challenging?
Despite this emerging optimism, it comes in the context of a longer-term economic malaise. Data released a fortnight ago drove this home. UK GDP per capita has been falling for seven straight quarters and now looks to be on a very different path to overall GDP. This matters for living standards and how people really feel in terms of their own wealth and income. Another piece of data in the same release flew under the radar but is equally, if not more, concerning. Real terms business investment once again flatlined in 2023, after showing signs of a strong recovery in 2022. Why aren’t businesses investing in the UK??
This is an issue we tried to tackle in our survey, with the usual suspects being highlighted – high interest rates (38% of leaders), high investment taxes (30%) and domestic economic uncertainty (30%). There’s no doubt these play a role, but they are predominantly short-term factors. The decline in business investment is a long-term problem.??
For me, it comes back to the fact that businesses fundamentally don’t see returns to investment in the UK. It’s no surprise that as corporate returns have flatlined, so has business investment. The chart below highlights the link between businesses' gross operating surplus and fixed capital formation. Since the end of 2016, gross operating surplus has flatlined while fixed capital formation is only marginally above where it was back then. It also shows the huge damage done to capital formation by the financial crisis. This might all seem obvious, but it’s often forgotten. Contrary to much of the noise, businesses' rates of return have not increased in recent years. According to the ONS , the services sector net rate of return is around 15%, the same as it was in 2013. Meanwhile, the manufacturing sector has seen its rate of return fall from 16% in mid-2014 to 9% now.???
The question then is, what is behind the poor returns to investment in the UK? This is a huge question, which I can’t fully do justice to now, but there are a couple of points I will mention. I think a lot comes back to the fundamental cost of doing business in the UK and the price and/or scarcity of key inputs such as energy, infrastructure and labour/skills.??
I’ve already mentioned our incredibly tight labour market. The UK’s industrial electricity prices stayed roughly level in real terms from 1984 to 2004. But in the next 10 years to 2014, they more than doubled and, in the following 10 years to today, they almost tripled.???
The story on infrastructure is equally problematic. We recently published a comprehensive assessment of the UK delivery of infrastructure and found that not only has the UK significantly underinvested for three decades, but when we do invest, we have a concerning combination of high unit costs and long times to delivery. Our infrastructure underpins our economy and we simply aren’t delivering the high-quality infrastructure needed to help businesses prosper.?
What does this mean for your business??
I’ll end on my usual note, trying to bring my random thoughts into some coherent insight for businesses. The potential for consumer demand to remain strong this year is clearly a positive for businesses, though as I noted in our last newsletter, this will be different for high- and low-income consumers. But the potential for inflation and interest rates to stay higher will be a challenge. While many have already adapted to this environment, there is a difference between it being temporary and more permanent. Finally, the cost of doing business is too high in the UK and is driven by several structural factors. Meaningful reform is needed here – let’s hope we can start to address this after this year’s general election.??