The ONS estimates that companies ran a financial deficit in the second quarter of £771m, or 0.2 per cent of GDP. This is the first deficit since the third quarter of 2002. This means that after almost 12 years of net saving, companies are at last becoming net borrowers, with their spending on inventories and capital equipment exceeding their retained profits. This could be a sign that the great investment dearth of the 21st century is fading away.
This matters enormously because companies’ reluctance to invest has been a major cause of the UK’s troubles. It explains why incomes grew so slowly even before the crisis. And, indeed, it contributed to the crisis. The worldwide reluctance of companies to spend their retained profits contributed to falling real interest rates in the 00s, which in turn led to a housing boom and “reach for yield” which led to rising malinvestments and the banking crisis.
For those that care about it, companies’ financial surplus has also been the reason for government borrowing. If one sector of the economy is lending, another must (obviously) borrow. In recent years, that other sector has been the government; since the ONS’s current data began in 1997, the government balance has been the mirror image of the corporate sector’s balance; the correlation between the two has been -0.87.
For these reasons, the return to deficit of the corporate sector – if it continues – could be tremendously good news. As companies invest more, growth should continue, and a rising corporate deficit could eventually reduce government borrowing and hence the perceived need for austerity.
Sadly, however, it’s too soon to celebrate. Although companies’ financial surplus has been on a trend decline since late 2009, their return to deficit in the second quarter is due in part to some less healthy developments. Financial companies’ net income fell in the quarter, as did non-financial companies’ dividend payments – and the latter could be a sign of a lack of confidence in the future. And insofar as spending increased, it was due more to a rise in inventories than investment in productive potential. Non-financial firms’ capital spending rose by only 1.1 per cent in the quarter, though it is up by 7.7 per cent in the last 12 months.
More worryingly, UK firms are in a minority in running a deficit. Today’s figures also show that the UK’s external deficit was 5.2 per cent of GDP in the second quarter. This means that foreigners, taken together, are saving more than they are investing; in particular, euro area companies are doing so. This is consistent with the continued decline in real interest rates.
This matters, because history suggests that big external deficits are unsustainable and lead to slower GDP growth. Whilst it is encouraging that the problem of UK corporate surpluses has diminished, the fact that the global investment dearth still exists is big cause for concern.
