Not investing

It’s tempting to blame this on Brexit. The uncertainty this is creating is causing companies to put investment plans on hold. While this is undoubtedly part of the story, it’s not all. Two facts tell us this. One is that business investment has fallen short of forecasts since Brexit. In March 2017, for example, the Office for Budget Responsibility (OBR) forecast that it would grow 3.7 per cent in 2018. In fact, it now looks as if it won’t grow at all. Also, even before Brexit, business investment was weaker than predicted. In March 2014, for example, the OBR forecast it would rise 17.9 per cent in 2014 and 2015. In fact, it grew only half as much. It’s hard to blame Brexit for that.

For years, economists have expected that low interest rates, high capacity usage and big corporate cash piles would boost capital spending. And they’ve been disappointed. This suggests some other factors are holding back investment. As there are tens of thousands of businesses in the UK there are thousands of possible factors. I’d cite five:

• A fear of technical change. If you invest in new robots, you risk being undercut in a few months’ time by a company that’s invested in cheaper or better ones. The prospect of rapid technical change can hold back investment.
• Credit constraints. The problem here isn’t merely that banks are loath to lend to companies – this has always been true – or even that companies fear that while credit is available now it’ll be withdrawn in the next downturn. It’s also that companies’ assets – and especially the assets of growing companies – are increasingly intangible: things such as good ideas, brands or companty-specific technologies and skills. One problem with these, as Stian Westlake and Jonathan Haskel say in Capitalism without Capital, is that these make for lousy collateral. And this means it’s more difficult to finance expansion.
• Illusory capital constraints. Economists had hoped that increasing capacity constraints would cause companies to invest in expansion. But this needn’t be the case, as a study of steel mill by Igal Hendel and Yossi Spiegel has shown. They showed that it doubled production over 12 years with the same plant because every time the mill seemed to be at “full capacity”, its managers found ways of tweaking production methods to eke out more output. “Capacity is not well defined,” they conclude. If this is true of an old economy steel mill, how much more true is it of intangibles-intensive companies that are more scalable? Capacity constraints, then, needn’t cause investment.
• Irrelevant profits. Profitability has been high recently. But this needn’t boost investment. For one thing, high profits tell us that past investments have been successful: they don’t tell managers much about the likely success of future, different projects. And for another, high profits needn’t persist: it’s perfectly rational to fear that rising wages might squeeze margins.
• Learning. In the past, investments have often proved unprofitable. Charles Lee and Salman Arif have shown that rises in capital spending lead to earnings disappointments. In part, this is because they, like shareholders, underestimate how hard it is to maintain profits while expanding. To the extent that managers have learned from these mistakes, capital spending will be lower now.

And here’s the thing. All these factors are structural, not cyclical. This suggests that while the (eventual) ending of Brexit uncertainty should give a boost to capital spending, this might be only short-lived. Sustained strong growth looks unlikely.