Strategy & Operations » Governance » Business confidence muted despite healthy economic outlook

THE EY ITEM Club Autumn Forecast sets out a path of steady if unspectacular growth for UK GDP of almost 2.5% per annum on average for the next three or four years. This is close to trend growth over the past three decades. Indeed, if we go back ten years, economic forecasts in late 2005 forecast an outlook for 2006 that was very similar to the one we currently have for 2016, and yet business confidence is muted. Why, given this reasonably healthy outlook, is business confidence not soaring ahead?

The answer lies with the fact that the UK economy has changed dramatically in the past ten years and businesses are finding understanding their current position and forecasting very difficult. In a changed economy, the future is no guide to the past.
To understand the future path of the UK economy, businesses need to look under the bonnet to understand how this new economy works. There have been four areas of significant change in the UK economy over the past decade or so.

The first change is the nature of the external environment facing UK businesses. In 2005, the global economy was booming and China was in a period of growth that ranged from 10% to 14% per annum over the decade. China’s advance created rapid growth in both commodities and goods trade, and while the whole world gained, it was the emerging markets that were the major beneficiaries.

Today, China’s economy is slowing as the government rebalances away from export and investment-led growth to a more consumption-based economy. Commodity prices have fallen and global trade is flat. By contrast, the developed markets have used aggressive monetary policy to restart their economies and the major economies, such as the US, Europe, the UK and Japan, are in recovery mode, albeit at varying speeds.

Second, the UK labour market has transformed almost beyond recognition since the onset of the crisis. Compared to the labour market in 2005, the UK currently has a greater proportion of workers aged over 50; significantly more self-employed and part-time workers; and significantly more workers in jobs paying £30,000 per annum or less.

As a consequence of this new labour market, there has been a shift in the demand for goods and services. A workforce comprised of older, less securely employed and less well-paid workers will consume in a different way than a more traditional labour force. The emergence of discount stores and payday lenders are examples of changes in response to a new pattern of consumption.

Third, the changing dynamics in the labour market will also affect business operating models. The more flexible labour market has meant that corporates have been able to use relatively cheap labour to maintain margins and minimise capital investment. While the broad trends in the labour market that have supported significant hiring are going to continue, the EY ITEM Club does envisage real wage growth.

EY ITEM Club’s recent special report on UK business investment showed investment was picking up but with wide sector variations. With the national living wage looming, the cost of labour will increase relative to capital and businesses are working to understand what this means for investment plans.

Finally, the financing market looks very different today than in 2005. There is almost no inflation and only a gradual pick-up is expected, so financing costs are low and are not forecast to return to anything like the levels that we were used to prior to the financial crisis. We can expect a long period of a historically low cost of capital.

Moreover, there is now an increasing range of sources of finance available, other than traditional bank finance. Traditional indicators such as bank lending and high-street interest rates do not tell the full story. Businesses need to incorporate the new dynamics of financing into their thinking and planning.

These four major changes in the underlying UK economy mean that businesses find themselves in a very different environment. Decision-making is more difficult as there is little precedent to rely on. ?

Mark Gregory is chief economist at EY UK & Ireland.

Read more
Business Regulation

The future of defined benefit pension schemes

By Shereen Ali | Deputy Editor
Corporate Finance

What are CFOs' business priorities for 2017?

By Shereen Ali | Deputy Editor

Brexit: Three key implications for CFOs

By Richard Crump | Writer
Accounting Firms
Corporate Finance

European mid-caps hungry for Asia growth

By Frank-Oliver Wolf & Martin Keller