EEF blog

After the Autumn Statement, Robert Chote gave a statement on the OBR’s view of the economic and fiscal outlook. Here is a summary of the key points.

Headline growth

The OBR expects the UK economy to grow 0.9% this year, and 0.7% next year, with most of next year’s growth occurring in the second half. Their projections suggest a roughly 1-in-3 chance that there UK will see a contraction over at least one quarter.

The productive capacity (and hence potential long-term growth rate) of the UK economy is lower than was previously thought. This means that by 2016 the economy will be about 3.5% smaller than the OBR thought in March.

Debt and the deficit

Weaker growth has implications for the government’s fiscal position. More of the deficit can be seen as structural, not cyclical (meaning there is further to go to reduce the targeted structural deficit).

The date the government will meet the fiscal mandate has been pushed back. There will be more real terms cuts to come beyond this spending review period. These cuts are, as-yet, unquantified, which means there will be more cuts for that the next government must make if the fiscal mandate is to be met.

Rebalancing

Firms have less cash available for investment than was previously thought, and tight credit conditions may be constraining the ability of the economy to reallocate resources to more productive areas

The OBR still expects rebalancing to happen: net trade and business investment are expected to be the sources of growth. However, the OBR’s forecasts for both of these have weakened.

Euro area

The OBR – like the Bank of England – did not quantify the potential risks of any sort of Eurozone “meltdown” though Chote did comment that there were three general ways in which the UK economy could be affected: reduced trade, credit tightening, and some impact (which could be positive or negative) on the government’s borrowing costs.

Labour market

Public sector job losses are expected to reach 710,000 compared with the 400,000 forecast in March.

Chote said that he thought that the youth jobs scheme would make little difference to overall employment levels, with some older workers being displaced by younger workers.

George Osborne has made a major improvement to the UK’s tax environment for R&D today by announcing in his Autumn Statement that the R&D tax credit will become payable ‘above the line’ from 2013/14.

This reform will increase investment from companies already the UK as well as bring additional investment in R&D to the UK.

The change means that rather than large firms accounting for the R&D tax credit in their tax return ‘below the line’, the benefit will be accounted for upfront in R&D budgeting ‘above the line’.

The key benefits of moving to an above the line credit are:

• Creating a simpler system;
• Strengthening the link between the R&D tax credit incentive and the parts of companies where investment decisions on R&D are made;
• Increasing certainty around the timing of the benefit of the R&D credit by decoupling it from a company’s tax profile.

Innovation is crucial for keeping ahead of the competition, generating better balanced growth, and creating high-value jobs.

When the R&D tax credit system was introduced it was a positive development for the UK. But our competitors do not stand still. Many countries have sought to incentivise greater expenditure on innovation and attract mobile R&D investments by introducing reforms to their own schemes to increase the incentive effect.

Today Mr Osborne has responded. He has made clear that the ambition he stated in March, to make the UK ‘the most competitive tax environment in the G20’ means the whole tax system, not just the headline rate. This is welcome news because it corresponds to how companies see the impact of taxes.

PwC has conservatively estimated this reform would deliver £665 million per annum of additional value to the economy at a net cost to the Exchequer of £205 million per annum. These are meaningful numbers at a time when the UK must be doing all it can to support growth.

Over the past few weeks we’ve been trying to highlight what we think today’s Autumn Statement from the Chancellor needs to deliver.

If the forecast revisions from the OBR are as bad as most of the media seem to be expecting, then our central claim, that the government’s Fiscal Mandate is most threatened by weak growth will be vindicated.

The government must act now to support growth.

This doesn’t mean throwing away its hard-earned fiscal credibility; quite the opposite – the two are intrinsically linked. That is why we have thought carefully about the options we have advocated on behalf of our members. We are not calling for unrestrained fiscal loosening.

Our central policy recommendation to address weak short-term prospects for growth is to bring in a temporary policy of 100% capital allowances for two years for new investments.

Why?

• The government needs investment to drive overall growth;
• Nose-diving prospects in Europe are causing companies’ to think twice about investment;
• The financial sector is becoming more nervous about supporting investment meaning cashflow is even more important to drive investment;
• Our medium-term competitiveness depends on firms investing now to stay ahead of the competition.

Critically this is a policy that is totally compatible with fiscal credibility. Capital allowances are already a legitimate expense representing depreciation that can be claimed by investing businesses, albeit over a longer timescale. For a given level of investment, within five years 63% of the cost to Treasury would be incurred anyway under existing parameters.

This policy would bring forward planned investments now and encourage more investment. But a ‘plan for growth’ doesn’t end here.

The Chancellor must start painting in the picture of his ambitions for growth by setting out how the UK can become the best place to do business in the G20.

What does our business environment need to look like in five years time to meet this ambition?

For our members it’s about focusing on four key areas, which we’ve been highlighting.

Reducing the tax burden: e.g. by compensating our energy intensive industries for the impact of carbon taxes; and making the R&D tax credit payable above-the-line

Improving access to finance: e.g. bringing down the cost of finance by boosting competition in the banking sector and increasing sources of debt and equity finance outside of banks

Decreasing the regulatory burden on businesses: e.g. by sweeping away stifling regulations holding back employment

Increasing the supply of skilled workers: e.g. by formalising the status of apprenticeships and improving and increasing maths and science education at secondary level.

We’ve seen some positive movements already from the Treasury on these areas including the package for energy intensive industries, Vince Cable’s employment regulation announcements last week, and the so far detail light credit easing plan.

In two hours time we’ll see how far the ChX’s commitment to growth runs.

EEF released its latest Credit Conditions Survey today and unfortunately the news is not good. A higher net balance of companies (17%) is seeing the overall cost of finance rise and worryingly after two quarters of improvement, a net balance of companies (3%) also saw the availability of credit worsen.

This is an additional barrier to investment when we can least afford it given the challenging short-term demand outlook is already a considerable deterrent.

Looking at just new lines of borrowing, a balance of 24% of manufactures reported an increase in cost, rising to 31% for just small companies. This compares with 8% and 3% respectively last quarter. A notable deterioration.

Also fees on existing credit lines, a pet-hate of ours and I think the clearest indicator of not enough competition in banking, increased for a balance of 21% of companies, the highest since 2011q1.

EEF’s own survey comes on the back of last week’s SME Finance Monitor, published by BDRC Continental and financed by the major UK banks, which showed that manufacturers were more likely to have new/renewed loan requests declined. In addition, 37% of new/renewed loan requests by manufacturing companies required security compared with 25% for the overall sample.

The situation must have the Chancellor worried ahead of tomorrow’s Autumn Statement. Treasury officials were busy briefing over the weekend on the ChX’s ‘credit easing’ scheme – basically designed to use the government’s ability to borrow cheaply to pass on lower costs to firms looking to borrow.

Lots of detail still to come on that but intent-wise credit easing looks positive – and at the least is a welcome admission from the government that the Merlin agreement was not a fix-all for UK companies’ access to finance issues. In particular the Merlin agreement to increase lending from the major banks had nothing to say about cost; whereas this seems the focus of credit easing.

The caution I would have is the mechanics of the scheme to ensure there is actually a benefit passed through to small companies looking to borrow – rather than a new implicit government subsidy to banks being gobbled up on the way through. Treasury is promising audits of lending books to ensure this ‘additionality’.

Even establishing additionality still might not help with the visibility of cost reductions for firms that borrow. This is because we are entering a period where banks’ funding costs are about to rise as many of them seek to refinance themselves in 2012 – potentially further hampered by any euro-meltdown.

But ChX is having a crack and we shouldn’t rush to judgement until we’ve seen a few more details.

Given Mr Osborne has now showed some enthusiasm for bringing the cost of finance down, would it be too presumptive to assume that ChX also plans a strong response on boosting competition in the banking sector when he responds to the Vickers Commission recommendations in mid-December?

Or has he used up all his ammo with the banks by a rumoured increase in the balance sheet levy to be announced tomorrow?

In the long run boosting competition in the banking sector has to be the focus of sustainable improvements in access to finance in the UK.

The government often makes the case for its climate policies by pointing out that, as well as being essential on environmental grounds, they are in the financial best interests of energy consumers.

The argument goes that weaning ourselves off coal and gas will reduce our exposure to ever more volatile and expensive fossil fuels.

So far, so plausible? Well, it’s certainly one possible scenario. But opinion is divided, with some seeing it as massive gamble on the future of fossil fuel prices.

What’s most worrying for manufacturers is that, according to government analysis published alongside this week's Annual Energy Statement, there will be no upside for them, however fossil fuel prices pan out, for at least the next twenty years.

The table below is an extract from yesterday’s analysis. It shows that the best case scenario for businesses is that the government’s policies will ‘only’ push up their electricity prices by 26% in 2020 and 29% in 2030.

The worst case scenario is truly alarming - policies will push up their by 51% in 2020 and 58% in 2030.

To recap, whatever happens to fossil fuel prices, if they go up or down, government policies will mean that businesses pay substantially more for their electricity.

This sounds less like a gamble, and more like a sure-fire way to place a losing bet.

Surely there must be a better way? A way cut to emissions without consumers being forced to pay such a high price?

EEF believes there is and in the second of our series of ‘Green and Growth’ reports, due to be published on 13 December, we will be setting out our alternative vision. Watch this space.

On Tuesday Paul Tucker from the MPC gave a speech about monetary policy in a rebalancing economy. A few remarks stand out

Rebalancing of the UK economy needs to happen…

… “the balance of aggregate demand needs, over the medium term, to shift away from household and public consumption towards net trade and investment”

But tight credit is causing problems …

“Rebalancing is already impeded by tight credit conditions…”

… and the instability in the Eurozone could make this worse

“With instability from the euro area crisis threatening the UK, our banks cannot avoid being exposed to outsized risks. That is reflected in elevated funding costs, which they pass on to customers to a greater or less extent”

“The gradual improvements in credit conditions seen until the summer, and documented in the Bank’s quarterly Credit Conditions Survey have been arrested for now”

Tucker argues that continuing constraints in accessing finance will “impede the rebalancing of the economy’s productive capacity” as credit can be a key part of firms' ability to invest, grow and enter new markets. This is particularly true for SMEs

Tucker states that loose monetary policy can help ease the costs for firms, but it is not the whole answer.

Ahead of the Autumn Statement on Tuesday we are calling on the government to do more to aid Access to Finance:

The government has already announced that it will look into credit easing, which is a welcome recognition of the problems on the supply side. However, the form that credit easing will take remains uncertain, including whether the proposals will have any impact in the near term.

This is why we are calling for the government to make the most of existing vehicles:

• One example would be the pre-existing £2.5bn Business Growth Fund. Government should use its existing relationship with the banks to encourage them to extend the scheme to cover debt as well as equity. Many smaller-business owners are reluctant to give up equity in their companies; a debt product could widen the pool of applicants to the fund. This reluctance on the part of SMEs could explain the low take-up of funding reported in today's FT.
• Another example would be extending Enterprise Investment Scheme eligibility to debt in line with the Business Angel Scheme, thereby increasing access to non-bank debt.

To improve the longer-term shape of finance and ensure banks are working for businesses, we are also looking for a positive response from the government on the Independent Commission on Banking’s recommendations on competition.

For more information on our key priorities for growth, see our submission to the Chancellor ahead of the autumn statement.

Today’s manufacturing investment numbers are a positive sign amongst all the economic doom and gloom we’ve been hearing. Some of the 15.7% growth in manufacturing investment over the quarter may be a result of the 95% of manufacturers currently covered by the £100,000 Annual Investment Allowance bringing forward investment ahead of the 75% cut in this allowance next year. Nevertheless, investment growth is a key part of a better-balanced economy and investment by manufacturers is clearly a key part of this.

However, it’s not what has happened that’s focusing our attention at the moment, but what’s about to happen.

The outlook for the economy is pretty murky. Anecdotally we have heard that ongoing problems in the Eurozone and fears this may spill into orders are starting to make manufacturers “sit on their hands” when it comes to investing. 

So despite good numbers (at least for manufacturing) today, we are calling on government to take strong action to support positive investment decisions in the next couple of years.

We are calling for the introduction of 100% first year capital allowances for a time limited period of two years for all new investments currently covered by the main rate.

Why this policy in particular?

Government is counting on sustained strong investment growth supporting the recovery. 100% capital allowances would provide a boost to companies’ cashflow, which is a key determinant of investment.

Cashflow is even more important for investment when firms are struggling to access finance. 100% capital allowances may therefore offset current struggles companies are having getting credit.

Why 100% Capital Allowances?

A study by the ICAEW found smaller capital allowances did not make any material difference to a firm’s investment decision but “substantial capital allowances, however, do seem to generate increased investment. For example the 100% first year allowance for computers offered in the past and incentives for energy-saving investments”

What is the impact on the government’s fiscal plan?

Economic growth is necessary for the government to achieve its fiscal targets. 100% capital allowances should support investment and therefore overall growth. Importantly strong investment in productive capital will also increase the country’s potential growth in the long-run.

The introduction of 100% first year capital allowances for a time limited period of two years over time would pay for itself. For a given level of investment, 63% of the cost would be recovered in five years and 80% by 2020.

However, it would add to the deficit in the short term, and may therefore not comply with the Chancellor’s immediate fiscal mandate.

But the point of the fiscal mandate is to illustrate the government’s fiscal credibility. And fiscal credibility is more complex than a tick in a box against one self-imposed target.

The introduction of 100% capital allowances for a two-year period does bring forward a cost to the treasury. But this is all it does. Over the long term increasing capital allowances for a limited period does not add to the debt as depreciation is a legitimate expense that can already be claimed for now – albeit over a longer time period. Therefore, over the long term, increasing capital allowances for a limited period would not impact upon the government’s fiscal position.

By introducing 100% capital allowances in the way we recommend, the government can demonstrate its commitment to genuine fiscal credibility and sustainable growth. Surely that’s what Plan A is all about?

Vince Cable was at EEF this morning to announce the proposed changes to employment law.

Some of the proposals announced today have the potential to make a significant difference for employers. For example, encouraging the use of pre-conciliation services to reduce the number of tribunals should reduce the cost and burdens associated with unnecessary employment tribunals.

The strong emphasis of the coalition government on reducing the regulatory burden is encouraging, as regulation is one of the key barriers to growth and it is one that is within the government’s control to affect.

In our Shape of British Industry report in 2010 we found that regulation is a major concern for manufacturers who rate it as the second-worst aspect of the UK business environment (after tax). More than half of respondents to our survey cited regulation as an obstacle to their growth plans.

Good news then, that we’re currently in the midst of a key period for regulatory change with a series of reviews and consultations being announced. Next Monday the Löfstedt review of Health and Safety regulation will be published and on the day of the Autumn Statement the results of the manufacturing Red Tape Challenge will be announced. In January there will also be news on Environmental regulation.

We will be looking for announcements on regulatory changes that will make a material difference to the burdens that manufacturers face, particularly those that are specifically holding back growth.

Some suggestions that have come out of the manufacturing Red Tape Challenge include:

• An export licensing system that supports growth by helping UK manufacturers compete in global markets. Member companies are reporting losing orders due to the protracted nature of the process and the lack of transparency over the progress of an application.
• Waste packing regulations that are proportionate to the environmental benefit they deliver.
• A fast-track process for changing an environmental permit where the risk of environmental damage is unchanged or going down. For example, where a building is being removed and/or an industrial activity is being discontinued at a site
• Greater consistency between health and safety inspections. Inconsistency costs firms money and negatively impacts on their businesses. Companies are reporting being asked by one inspector to make costly safety modifications to machinery only to told by another on a follow-up visit that the measures were unnecessary.
• A more efficient process for dealing with small injury claims. The fast-track system for small claims is slow and inefficient. As well as often taking months or years, the legal costs for claims settled at the earliest possible opportunity are very nearly equal to the full value of claim. A protracted process is not in the interests of employers or injured employees. 

For more information on our key priorities for growth, see our submission to the Chancellor ahead of the autumn statement.

A week today the Chancellor will stand up to give his Autumn Statement. While much of the political debate had been focused on deficit reduction versus deficit spending, but the intensification of the Eurozone debt crisis has made one thing abundantly clear: sustainable debt and growth both matter.

Not only does the Chancellor need to reduce the deficit (and eventually the debt), but he also needs to boost growth. This is crucial because weak growth could undermine the government’s fiscal plan as much as over-spending.

So what should the Chancellor do? Given the tumult that unsustainable debt-mountains have caused across Europe, it is clear that the government must maintain its fiscal credibility. Markets need to know that the UK’s debt burden is under control. But, there is a balance to be found between medium-term fiscal credibility and providing a short-term boost to the UK’s growth and its long-term potential to grow. 

There have been a series of suggestions about tax reforms that the government could enact such as…

• an overhaul of government support for business angels to provide new tax breaks for the smallest start up companies (reported in the FT)
• merging PAYE and National Insurance payments (reported in This is Money)
• abolishing the 50p tax rate (reported in the Telegraph)

While these reforms may well be welcomed by business, when the government’s fiscal position is as constrained as it is, what we're interested in are policies that will have the biggest impact on incentives to invest and grow: government should prioritise reforms that will have a measurable impact on growth now and in the longer term.

Business investment and innovation are needed to drive the long-term sustainable growth this country needs. The tax system must be reformed to incentivise this innovation and investment.

Our key recommendations would provide a short-term boost, while supporting the competitiveness of the UK in the longer term. They include:

• Making the R&D tax credit more effective at increasing innovation by making it payable above the line, and therefore applicable to loss-makers
• Overhauling the tax treatment of capital to better reflect the life-span of modern machinery.

For more information, see our submission to the Chancellor ahead of the autumn statement.

Jobs. We need more of them. It’s an issue that keeps the government up at night. Various reports have it that the government is considering options for making employment laws friendlier to employers. Fewer restrictions will make it easier for businesses to justify taking on new staff.

That’s got to be a good thing and EEF has played its part through the Red Tape Challenge in suggesting candidates for reform. We'll hopefully be hearing more specifics from Vince Cable when he comes to EEF's London office on Wednesday.

But is there more to do to encourage employment beyond regulation?

Youth unemployment has cracked a million. This is a big issue of wasted resource sitting there idle – economically costly let alone the negative social impact.

Manufacturing is not going to be a source of mass youth employment. But we do hear fairly continuous noises about a lack of skilled staff available for our members to hire. Companies are always on the lookout for good staff.

Skills is one of four key policy areas we identified in our submission to the government in advance of the Autumn Statement that the government should focus on in enhancing the UK business environment.

What’s wrong with our skills system and how can we connect a large pool of potential workers with what demand is out there?

Firstly some positives.

It's good the government has signaled its deserve to growt the number of UK apprenticeships and to refocus FE training providers generally on the needs of employers.

But manufacturers continue to report difficulties in filling both apprentice and graduate vacancies with adequate foundations in maths and science.

Informing students about career opportunities in engineering and manufacturing is important to breaking the monopoly university-based education seems to have on maths and science students’ imaginations.

We must ensure a strong pipeline of interested and properly qualified young people are coming through from the secondary education system. STEM careers advice should be part of subject curricula and included in continuing professional development training for science teachers.

This is really a specific instance of a wider point about engaging the education system at the secondary level with the needs of employers.

Another important change from the employers’ perspective is clarifying the legal status of apprenticeships. This is important because the legal status has implications for what rights must be afforded to apprentices and thereby how willing employers are to taking on new apprentices.

29 November is the government's Autumn Statement where OBR forecasts will likely show grow expectations having deteriorated sharply. Addressing skills issues in the UK economy has to be part of the response.