To ensure we do not continue down a path of economic inequality, we need meaningful policy changes towards investment-led growth – that means an economy that’s more balanced, more productive and more inclusive.
The UK economy isn’t working. That’s the stark conclusion reached in the Institute for Public Policy Research’s Commission on Economic Justice. On some measures, living standards have stagnated over the past decade. The UK’s investment rate stands at around 17% of gross domestic product (GDP) – four percentage points lower than the OECD average and the rate has been falling for most of the last 30 years. It’s clear that the world’s changed in the last 40 years and we need an economy that’s going to thrive for the next 40 – that’s why following my work as part of the commission, I’m suggesting a decisive shift towards investment-led growth.
Investing for longer
The rise of ‘short-termism’ has certainly been a well-documented factor of falling business investment. Over the past 20 years or so, as the structure of shareholdings has changed, the UK’s capital markets have increasingly prioritised short-term returns over long-term success. In some cases, remuneration packages and share buybacks incentivise senior executives to keep share prices high in the short term, rather than investing for the future. There has been some recent progress with FTSE100 companies moving away from reporting quarterly earnings, but a rising proportion of those earnings have been distributed to shareholders rather than being re-invested into the business.
We need companies to be more purposeful and focused on long-term value creation, not short-term returns, with executive pay incentivised to achieve it. That means clarifying and enforcing directors’ duties in the Companies Act, so that the primary duty of directors is to promote the long-term success of the company. It also means simplifying executive pay packages and linking them to the long-term drivers of value, not just short-term share price movements.
The role of other company stakeholders, such as employees, should be strengthened. Companies with more than 250 employees should consider how best to ensure the perspective of workers, who have a vested interest in the future of their company, is properly taken into consideration at the board level.
Banking on Britain
Another cause of low investment is that banks in the UK are not lending enough to businesses. Business loans account for just 5% of total UK bank assets, around a third of the proportion typical in the Eurozone. Instead, British banks are much more focused on lending money for people to purchase land or property but unfortunately that does not help economic productivity.
Business loans account for just 5% of total UK bank assets, around a third of the proportion typical in the Eurozone
As might be expected, the consequence of banks lending more people money to buy houses is that housing becomes more expensive, making it harder for young people to acquire enough capital to buy their first home. Reforming the finance sector to help banks focus more on business growth could provide much-need access to capital for small businesses.
The third reason that we have such a low investment rate is that demand in the economy is too weak. Companies invest when they think they will make a profit because people will buy the goods and services they produce. But since the financial crisis, the UK has suffered from a demand deficiency. We lag behind the rest of the G7 countries on levels of public investment, especially in research and development and infrastructure, which helps drive demand up as more jobs are created.
A long-term problem has no quick solution
As a result, the UK has an unbalanced model of growth. Exports have been rather weak as businesses held back from investing. According to the Office of Budget Responsibility, last year nine-tenths of all UK economic growth came from household consumption at a time when savings are at record lows. The problem is that too much of this has been financed by rising household debt, which has been on the increase since 2016 and set to reach 146% of disposable income by 2023. Needless to say, this state of affairs is unsustainable!
The government’s promise to raise public investment is welcome but still lags the G7 average of around 3.5% of GDP, an amount which would require around an additional £15 billion per year. A long-term problem has no quick solution – raising investment means a slower rate of household consumption growth, and a higher rate of savings.
Investors, business and government hold the answer
As the country’s demographics change, we’re running out of workers to support the services people expect in their retirement. While productivity remains low and as monetary stimulus is unwound, asset prices may struggle, so adopting a long-term outlook will be essential.
Portfolios must be managed to consider the long-term implications of environmental, social and governance issues. If unmanaged, these factors could cause risks and have a material impact on investments. We need a joined-up approach to long-termism, with investors, businesses and government all playing their part.
At LGIM’s client conference, pension-related theatricals took place alongside discussions of ‘digital humans’ and the long-term trends dominating the investment landscape.