3.37 The ratio of whole economy fixed investment to GDP has consistently been well below the OECD average since at least 1960, and the gap has been widening in recent years. Since 1960, the investment-GDP ratio for the OECD as a whole has averaged around 21 per cent, compared with a UK figure of 18 per cent. Between 1960 and 1994, the UK invested a lower share of GDP than any other OECD country. On the other hand, the UK's record on plant and machinery (and business) investment has not been so clearly out of line with other industrial countries. However, it seems unlikely that the UK can catch up, or at least narrow the gap, with its main competitors in terms of the level of GDP per head without a significant rise in the ratio of investment to GDP.
3.38 Whole economy saving has also been low relative to income by the standards of the rest of the industrialised world. The difference between domestic saving and investment is equivalent to the balance of payments current account balance. Despite international capital mobility, the current account has not tended to drift a long way from balance for protracted periods of time. In other words, there has been a fairly close association between domestic saving and investment over the cycle.
3.39 The investment recovery over the past five years has been weak by historical standards. During the current economic upswing, the ratio of whole economy investment to GDP has fallen continuously, in contrast to the 1980s recovery, though this time round it has fallen from an historic high rather than rising from an historic low. In 1996, it was lower than for most of the past 30years. While output has increased by 15 1/4 per cent from its trough at the beginning of 1992, total investment has increased by only 10 1/4 per cent.
3.40 Sluggish whole economy investment mainly reflects falling general government investment. Business investment, which accounts for around 65 per cent of the total, has been stronger; but it has still grown at a slower pace than in the 1980s recovery. From the trough of output, total business investment has increased by 17 1/2 per cent compared to the increase in GDP of 15 1/4 per cent. (In contrast, while GDP increased by around 15 per cent in the first five years of the last upswing - between early 1981 and the end of 1985 - the increase in business investment was 23 1/2 per cent.)
3.41 Manufacturing investment has been relatively weak. It remains almost 13 per cent below its 1990 peak, and last year its ratio to GDP fell to the lowest level since at least 1955.
3.44 While domestic demand is expected to continue growing strongly through this year, the high exchange rate is likely to hit profitability, especially in the traded goods sector, and lead some manufacturers to postpone investment plans. Manufacturing investment is therefore expected to rise only modestly over the next 18months.
3.45 Non-manufacturing business investment (which includes investment in private sector services, construction and the utilities) grew by 9 3/4 per cent last year, and by a further 7 1/4 per cent in the first quarter of this year. But it is still only 3 3/4 per cent above its level at the pre-recession peak. According to the British Chambers of Commerce survey, investment intentions in services remain strong, while capacity utilisation has continued to rise over the past year and is now back to 1989 levels. Service sector firms are more sheltered from the effects of sterling's appreciation than manufacturers, and it is likely that they will need further to increase investment to meet higher domestic demand. Investment will also be boosted by the growing number of Private Finance Initiative projects and projects aided by the National Lottery and Millennium funds.Profits
3.42 The profits of industrial and commercial companies (ICCs) rose by over 10 per cent last year. However, dividend payments also rose strongly - they were 13 1/2 per cent up on 1995 - and there was therefore only a small increase in ICCs' undistributed income. Nevertheless, the rate of return on investment remains high by historical standards, and while a balance of 20 per cent of manufacturers in the April CBI survey cited a lack of internal finance as a constraint on investment, this is no higher than the long-run average for the series.Business investment
3.43 Manufacturing investment bottomed out at the end of 1993, and recovered strongly in 1994 and 1995 as activity strengthened and capacity utilisation increased. But it then fell again last year, by 5 1/2 per cent, despite business surveys consistently showing strong investment intentions. It appears that this fall partly reflected firms' uncertainty about the strength of demand. Over the past year, an increasing proportion of manufacturers in the CBI survey have been reporting uncertainty about demand as a factor likely to limit investment, and in recent years this has been a more significant constraint than in the 1980s recovery. Despite a sharp increase on the previous quarter, in the first quarter of 1997 manufacturing investment was 4 1/2 per cent lower than a year earlier.
| Percentage changes on a year earlier | |||
| Forecast | |||
| 1996 | 1997 | 1998 | |
| Whole economy(1) | 1 3/4 | 5 | 6 |
| of which: | |||
| Business(2),3 | 5 3/4 | 9 1/4 | 6 1/4 |
| Housing(2) | - 1/4 | 7 | 5 |
| General government(2),4 | -13 1/2 | -15 1/2 | 9 1/4 |
1 Includes transfer costs of land and existing buildings.
2 Excludes net purchases of land and existing buildings.
3 Private sector and public corporations (except National Health Service Trusts) non-residential investment. Includes investment under the Private Finance Initiative.
4 Includes National Health Service Trusts.
3.50 The stock-output ratio rose during 1995, as heavy stockbuilding cushioned the impact on output of slackening demand growth. But it then fell back again as lower stockbuilding in the middle of last year held back output growth at the time when final demand was strengthening.
3.51 Stock adjustment now appears to be largely complete: both manufacturers and distributors destocked in mid-1996, but there has been a return to stockbuilding in these sectors since the fourth quarter. In manufacturing, a rise in stocks of work in progress in the first quarter of 1997 is consistent with manufacturers expecting recent increases in output to continue (while a fall in manufacturers' stocks of finished goods suggests that actual demand may have been stronger than expected). In retailing, although the ratio of stocks to sales is relatively high, there is little survey evidence that retailers are carrying excess stocks, and increases in stocks probably reflect expectations of strong domestic demand.
3.52 The forecast assumes a resumption of the long-run downward trend in the stock-output ratio, with movements in stockbuilding making little contribution to the forecast of GDP growth over the next 18 months.
3.54 But the decline was particularly rapid during the second half of the 1960s and the 1970s. This decline was accelerated in the late 1970s and the early 1980s by the loss of price competitiveness associated with the appreciation of the exchange rate. In terms of the proportionate loss of market share, the UK's performance in the 1970s was the worst of the major six industrialised economies.
3.55 Since the early 1980s, the UK's share of world trade has continued to trend downwards, though at a slower rate than in previous decades. It is likely that this relative improvement in export performance reflected a number of factors, including a shift in the geographical and product mix of world trade growth in favour of the UK, an improvement in the relative quality and variety of UK exports, and an increase in foreign direct investment in high-technology, export-orientated industries.
3.56 However, at around the time when these more favourable developments in export performance started to emerge, the trend in import growth picked up and the balance of trade in manufactures moved into deficit. Exports are dominated by a relatively small number of large companies, while imports compete against a wider front of domestic industry and so give a more representative indication of competitive strength. The relatively rapid growth of imports during the 1980s and the persistence of the trade deficit since then suggest ample scope for improvement in the underlying strength of British industry.
3.58 There is likely to be some considerable delay before the appreciation has its full effect on export volumes:
3.61 However, there is increasing survey evidence that the high exchange rate is now beginning to reduce export orders. The May CBI survey reported that manufacturing orders had fallen to their lowest level relative to normal for three and a half years, and although they improved slightly in June they remain below their long-run average. And the latest BCC survey reported a slowdown in the growth of export orders in both manufacturing and services. Despite the expected pick-up in the growth of UK export markets, export volume growth for goods and services is forecast to slow to an annualised rate of around 4 1/2 per cent in the second half of this year and the first half of 1998.
Trade and the balance of payments
Longer-term trade performance
3.53 The UK's share of world trade in manufactures has been falling over time, at least partly reflecting developing countries "catching up" with industrialised countries such as the UK and also trading more amongst themselves.Competitiveness
3.57 As a result of sterling's appreciation since last summer, cost competitiveness has deteriorated sharply. The deterioration in export price competitiveness appears to have been smaller, as manufacturers have allowed their profit margins to be squeezed.World background
3.59 UK export market growth slowed sharply in the first half of last year, reflecting the slowdown in activity in Europe. But with Europe picking up and healthy demand growth expected in the US, UK export market growth is forecast to increase to 7 1/2 per cent this year and 7 3/4 per cent in 1998. Details of world economic developments and prospects are set out in Annex A.Export volumes of goods and services
3.60 There is little evidence that the appreciation as yet has had an adverse impact on export volumes. The volume of exports of goods and services continued to expand through the second half of last year, and in the fourth quarter they were still over 7 per cent higher than a year earlier. Export volumes have increased further so far this year - rising by 1 1/2 per cent in the first quarter.Import volumes of goods and services
3.62 Import volumes have been rising on the back of strengthening domestic demand, though they have been erratic from quarter to quarter. The decline in import price competitiveness appears to have been modest in relation to the exchange rate appreciation, reflecting only partial downward adjustment of import prices combined with downward pressure on the prices of domestic manufactures. Import volumes of goods and services are forecast to grow by 7 1/4 per cent in 1997 and 7 3/4 per cent in 1998, as the effects of the higher exchange rate feed through against the background of still buoyant consumer demand.
| Percentage changes on a year earlier | £ billion | ||||||||||
| Volumes (1) | Prices (1),2 | Goods and services balance | |||||||||
| Exports | Imports | Exports | Imports | Terms of trade (3) | |||||||
| 1996 | 7 | (7 1/2 ) | 8 1/2 | (9) | 1 3/4 | ( 1/2 ) | 1/2 | (- 1/2 ) | 1 1/4 | (1) | -5 1/2 |
| Forecast | |||||||||||
| 1997 | 6 1/4 | (6 3/4 ) | 7 1/4 | (7) | -5 | (-5 3/4 ) | -6 1/4 | (-6 1/4 ) | 1 1/4 | ( 3/4 ) | -5 |
| 1998 | 5 | (5 3/4 ) | 7 3/4 | (8 1/2 ) | 1 1/2 | (1 1/4 ) | 1/4 | (- 1/2 ) | 1 1/2 | (1 3/4 ) | -8 1/4 |
2 Average value indices.
3 Ratio of export to import prices.
| £ billion | |||||||
| Non-oil goods | Oil | Services | Total goods & services | Transfers | Net investment income | Current balance | |
| 1995 | -16 | 4 1/4 | 7 | -4 3/4 | -7 | 8 | -3 3/4 |
| 1996 | -17 1/2 | 5 | 7 1/4 | -5 1/2 | -4 3/4 | 9 3/4 | - 1/2 |
| Forecast | |||||||
| 1997 | -16 3/4 | 5 1/4 | 6 3/4 | -5 | -6 1/2 | 5 1/2 | -6 3/4 |
| 1998 | -19 1/2 | 5 1/2 | 5 3/4 | -8 1/4 | -6 1/4 | 5 1/2 | -9 3/4 |
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