How to make the most of the economic recovery

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The economic environment is always uncertain, but perhaps never more so than now. I regularly travel across the UK to meet business people and, irrespective of the town or city I visit, the same issue dominates discussion: uncertainty relating to the economy.

As a result, the appetite among businesses for information on the direction the economy is heading is acute. The number of events the Institute of Directors’ regional offices and branches are holding on the economic outlook has never been greater. This is not surprising given the volatility of indicators – one day the latest economic statistic suggests interest rates might need to go up; the next that they should remain on hold.

Business always realised that this recovery would be different in the wake of the financial crisis, but quite how different has taken many by surprise. Quarterly gross domestic product contractions during the upswing are doing little to boost confidence.

Access to finance – or, specifically, the variation in availability – is still a big problem for regional businesses. Naturally, there are differences between large companies with access to relatively cheap finance via capital markets, and smaller enterprises that are much more dependent on the banking sector. But even when the banks do offer credit lines, the cost may be too high for smaller enterprises in terms of the price of that borrowing or the collateral required.

In 2009, IoD economists forecast what they called “one L of a recovery”. By that they meant not a sharp, V-shaped bounceback, but something closer to an L shape – not horizontal, but a much weaker shaped recovery than the norm.

The IoD has not changed that view and remains cautious, forecasting GDP growth this year of below 1.5 per cent.

Three factors drive this forecast: the squeeze from higher taxes and inflation on household income; high levels of indebtedness and low levels of saving compared with previous cycles; and the ongoing legacy of the financial crisis.

But UK growth of 1.5 per cent is an average across the entire country, implying that certain regions will be much weaker. My impression, from numerous conversations with companies north and south, east and west, is that the southern economy is performing best. If I am correct, regional rebalancing remains elusive. This is unfortunate, but does not mean that the government should be targeting particular regions with subsidies – this rarely, if ever, delivers value for taxpayers.

So what should the government do? All the talk of the need for a fiscal “plan B” to improve demand in the economy misses the point. What is needed is a parallel supply-side plan to match the spending squeeze on the demand side of the economy.

An obvious starting place is to deregulate parts of the employment law framework. Over the past 15 years, law in this area has become increasingly complex and restrictive, with companies having to create larger human resource functions to ensure compliance. This is a state-generated overhead that needs to be checked and, ideally, cut.

We also need to find radical ways of encouraging our local authorities to become more focused on supporting regional and local businesses. A quick and obvious step would be to allow those councils that increase the total rateable value of properties in their area to keep some of the increase in business rate income. This would give them a genuine incentive to develop local policies to boost private sector growth.

Linked to this idea of driving regional and local development should be a relaxation of the residential planning system. With increasing population pressure, particularly in the south-east of England, there is surely an opportunity to release a portion of green-belt land for development. This could help boost the construction sector and economic recovery in the short term, while improving urban congestion in the long term.

It would also be wise for the government to look at how the tax system might be tweaked to boost capital injections into new enterprises. One option the IoD is keen to see taken forward is an exemption from capital gains tax for subscribers to shares in any new company set up between now and April 2012 when they sell those shares, whenever they sell them. This would encourage the injection of fresh equity and be a particular spur for owner-managers and entrepreneurs.

While the IoD strongly supports the government’s spending review, it would have been better if the fiscal squeeze had been undertaken solely on spending – avoiding higher national insurance. However, the politics always made this unlikely.

Where tax policy should change, and change as soon as possible, is with regard to the 50p income tax rate. Regional businesses that would benefit from more inward investment into the UK are likely to be the ultimate losers. Aggressive tax-avoidance schemes and relocation out of the country suggest that the 50p rate will end up being a revenue loser that damages foreign direct investment into the UK.

There is one final point: much talk about the possibility of a mistake in fiscal policy risks ignoring a potential policy error with regard to monetary policy. Money-supply growth is near zero, yet the media and financial world focus on the need to raise interest rates to suppress inflation.

The IoD understands this argument but remains concerned at the prospect of increasing interest rates when money growth is close to zero and, if anything, screams a louder case for quantitative easing than when it was introduced in 2009. This is a contentious area that once again highlights how very different the recovery is to previous upturns.

The writer is director-general of the Institute of Directors

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