Technology and the UK productivity gap

The most recent data from the ONS shows that employment levels are continuing to rise, while at the same time GDP is continuing to stutter, with the UK on the brink of an unprecedented triple dip recession.  These contradictory trends may be a result of past underinvestment in technology and equipment infrastructure by businesses, which raises important questions about both companies’ future investment plans, and how those plans can be funded.

The UK has a long-standing productivity gap with each worker responsible for less economic output than their German and other European cousins, but the gap is now widening to such an extent that economists are starting to refer to a ‘productivity puzzle’, and wondering what other factors are at play.

One possible culprit is the dramatic and prolonged decline in business investment.

Many businesses made steep cuts in spending in the wake of the financial crisis, and the UK manufacturing representative body the EEF estimates that UK business investment is now 15% below its pre-2008 levels, and lagging behind global competitors.

Fortunately the slump in investment is starting to reverse, with the first signs being a recent ONS report that spending on Research and Development (R&D) in the UK reached £17.6bn in 2011, an 8% increase on 2010.

Overall business investment increased by £1.1 billion in the final quarter of 2012, up by 3.8% compared to the previous quarter. However, growth in business investment over the course of 2013 is forecast by the ICAEW to fall by 0.9% in real terms.

Clearly, while the economic situation remains uncertain, businesses are still wary of investing significantly in their own growth, as owner managers and shareholders alike worry about the likely return on investment.

This hesitation has been exacerbated by a lack of affordable funding available  – high borrowing costs have made  investments less attractive for businesses. This has led to businesses missing out on new potential opportunities and many are struggling to remain competitive because of their underinvestment in new equipment and technologies.

An under-investment in technology may also be affecting businesses’ ability simply to keep pace with their pre-recession output.  Businesses which last made major investments in technological infrastructure in the 2008 period would now be reaching the end of the product’s lifecyle and will require updated technological infrastructure to remain competitive, and maximise output.

IT equipment resellers still note a resistance among businesses to commit to investments, however vendor specialist Syscap has seen that there is an increasingly strong underlying demand for new software and hardware. Businesses that have also been sitting out the last few rounds of technology development due to fear over the economic situation, are now keen to get up to date.

In particular, as confirmed by research by KPMG Global Pulse,   new reporting and analytics software are among the hottest must-haves at the moment, because organisations are concerned that they do not have the processes in place to handle a potential upturn in demand.  They hope that new reporting and analytics software will help them to make better business decisions faster.

So, what can be done to help convert this pent-up need for new investment into actual investment?

The Government is very aware of the need to encourage businesses to invest.  In the pre-budget statement they announced a temporary increase to the Annual Investment Allowance to £250,000 for two years.

That is a very useful step, though we would like to see the Chancellor encourage businesses to start developing long-term investment plans by keeping the Allowance’s ceiling at £250,000 permanently.  The evidence of the last couple of years during which it has been raised from £50,000 to £100,000, then reduced back to £25,000 suggests that short term incentives have had a reasonably limited impact on businesses’ spending plans.  Greater certainty over tax allowances will give businesses more time to develop major investment plans.

Business investment should also be on the agenda for the incoming Governor of the Bank of England.  Appearing before the Treasury Select Committee earlier in February, Mark Carney indicated that he would consider giving guidance on how long interest rates were likely to stay at their current ultra-low levels.  This is something that Syscap has been advocating for some time.  Greater certainty over the long-term cost of finance will certainly help to encourage businesses to invest.

Despite significant public money being put aside, for example through the Funding For Lending Scheme, and a major push to get banks to lend directly to businesses, we have not seen the volume of loans being distributed to small businesses recover.   In fact, last year, bank loans to businesses fell by 2.8%. This has led to many businesses pursuing other financially viable options to seek viable funding.

More and more companies are now relying on asset finance, including leasing, to invest in IT equipment. Over the last year, asset finance used by UK businesses investing in technology, such as IT and software, increased by 26% to over £1 billion.

The use of asset finance to invest in technology far exceeded the overall growth in asset finance, which increased by 3% over the same period.  This suggests that after a long period of underinvestment, technology is top of businesses’ shopping lists, and that companies are also choosing to fund their investment through asset finance

The reduction in reliance on bank funding by SMEs has resulted in some advantages for businesses that have sought out alternatives instead. Bank-provided lending instruments such as overdrafts can be discontinued at almost no notice, causing major cash flow issues for the business. Even long term loans can be withdrawn from businesses if the company’s turnover or profitability falls below a threshold set by the bank as a pre-condition of its lending. Lease finance, however, stays in place as long as the business is able to make its payments.

Additionally, because leasing does not affect a business’s other credit lines, it gives the company more scope to borrow money when it needs it in the future along with the opportunity to keep hard-won cash reserves for a rainy day.

These cash flow management advantages can make leasing a very attractive way to invest in new technology.  This is especially true for smaller businesses, as with a smaller number of customers, one late invoice can be more damaging.  This makes it especially important that small businesses considering a technology purchase understand the range of funding options available.

In our view this dramatic increase in businesses using asset finance to invest in technology is a positive development. Any sign that businesses are getting fresh finance to invest in IT hardware and software is very welcome. Leasing allows a business to invest in IT without reducing its vital cash facilities and without necessarily adding to the level of debt that a business carries on its balance sheet.

It may take years for the UK economy to fully recover from recent underinvestment, but the signs are that a recovery is starting to take shape. Businesses are increasingly aware that they cannot wait for bank lending to return to its pre-financial crisis levels.  Underinvestment has really started to hurt, and replacing outdated software and creaking hardware has become a priority for many businesses.

If the technology and financing industries can work together to help businesses to make their investment plans a reality, this could result in significant improvements to businesses’ and the nation’s output, giving economists one less ‘puzzle’ to worry about.