Insights
Business investment is an important driver of economic growth and low levels of business investment are regularly cited as one of the reasons UK economic growth has been subdued in recent years.
Business investment is spending that increases or improves the capital stock of a business – i.e. the durable assets used to produce goods and services. For example, a bakery’s capital stocks will include ovens, mixers, vans, and buildings, known as tangible assets. The bakery might also have intangible assets such as branding, software, and intellectual property (secret recipes!).
One challenge for local policymakers is that data on business investment is limited. Whilst data like gross fixed capital formation or foreign direct investment can provide useful insights, they rarely offer precise answers to the questions local policymakers have.
For this reason, local policymakers should also consider other data and broader economic insights. Below we set out three things to consider.
Understand what underpins local performance
Low business investment is often attributed to challenges in accessing finance. For example, there may be information asymmetries between lenders and borrowers for some projects (such as a novel technology) which result in investments that could have economic benefits struggling to access finance.
In reality, many businesses self-fund investment through retained profits. And where businesses do seek external finance, surveys show most businesses are successful. For most areas, access to finance is unlikely to be the main reason for low business investment. We should also be careful not to assume external finance is used for investment. The evidence is that it is more often used for day-to-day operations.
Local policymakers should aim to understand the causes of low business investment in their area and target interventions at addressing those issues. Many issues – such as low levels of business ambition or challenges in assessing different technologies or market opportunities – can be addressed through business advice. In other cases, complementary investment (for example, ensuring commercial spaces is available for businesses looking to grow or skills provision is available to help them maximise value of their investment) will give businesses confidence to invest.
Think through how investment contributes to local outcomes
When thinking about whether and how to intervene, policymakers should consider what outcome they are trying to achieve. For example, investment into new commercial property to enable businesses to grow may primarily contribute to the local economy through job creation. In contrast, supporting businesses with energy efficiency measures or to develop a new production process is less likely to contribute to employment (at least in the short term) but should hopefully lead to improvements in productivity. Interventions should align with the objective required. Our logic model resources can assist with this.
As well as establishing what outcome they are seeking to affect through business investment, policymakers should also consider the likelihood that the intervention will lead to the outcome. Not all business investment delivers its anticipated benefits. One reason for this is that quality matters. Poorly targeted or speculative investments may fail to increase employment, productivity, output or wages.
Another consideration is whether benefits in one area are offset by disbenefits elsewhere. For example, investment in software to manage finance or human resources can help reduce costs and increase productivity and competitiveness of the business – but may mean fewer staff are required. Thinking through these trade-offs can provide a better assessment of the proposed intervention.
Consider the role of public investment
Public investment increases the capital stocks provided and maintained by government for societal benefit, such as roads and rail networks, schools, and hospitals. Public investment can influence business investment. For example, when the public sector invests in the transport network, this can improve access to markets for businesses or help them recruit from a wider pool of individuals. Over the longer term, it may encourage businesses or individuals to relocate to the area. All of these suggest positive economic impacts on the local area. This effect is known as ‘crowding in’.
More negatively, public investment can also ‘crowd out’ private investment. At local level, this normally reflects increased competition. For example, if the public sector builds workspace for start-ups, this may discourage business from developing a commercial space to serve this market.
Local policymakers should consider whether there are public investment projects that would help encourage business investment, either by lowering their costs or by increasing confidence. When assessing projects, it is important to identify whether there is a market failure and carefully assess whether there are potential downsides (such as displacement and crowding out).
Final thoughts
Local government can play a key role in creating conditions that encourage business investment. Thinking about what underpins low levels of business investment in the local economy, the objectives of any intervention and their likelihood of success, and how to utilise public investment to encourage business investment can help shape effective policy interventions.
More detail on investment is available in our ‘how to’ guide on understanding local investment. We also recently hosted a webinar on business investment – watch the video here.
