How can the UK revive its economy?

Guy Foster
Chief Strategist
RBC Brewin Dolphin

Last year, the UK government published Invest 2035: the UK’s modern industrial strategy – and it wasn’t alone. Governments worldwide are making investment a top priority. But the term ‘investment’ is as vague as it is vital, raising major questions about the state of the UK economy. Is investment really the Achilles’ heel of the UK economy? If so, what can be done about it? And will any changes affect your wealth? Let’s break it down.

Why investment matters

Investment is a broad concept that always involves sacrificing something today for the hope of gaining something more tomorrow. For individuals, this could mean buying shares or funding a pension. For businesses, it’s spending on equipment, technology or ideas to fuel growth. While connected, individual share purchases don’t directly boost company investment.

For an economy, investment is intended to improve productivity, enabling workers to become more efficient. This, in turn, allows wages to rise faster than inflation. Without sufficient investment, growth stalls, wages stagnate, and opportunities diminish.

So – where does this leave the UK?

At first glance, it’s easy to see why pessimism surrounds UK investment. Levels are among the lowest in the G7, at under 18% of GDP, as measured by Gross Fixed Capital Formation (GFCF) – a term for spending on tangible assets like buildings, machinery, and infrastructure. Both the government and private sector in the UK spend less than their peers on investment. While low investment is often a criticism of the serving government, this trend has persisted irrespective of who’s in power.

A new perspective: tangible vs. intangible investments

Traditional investment measures like GFCF only tell part of the story…

GFCF focusses on tangible assets – things like factories and machines. Yet in today’s service-driven, knowledge-based economy, intangible assets – such as software, R&D, design, branding, and firm-specific training – are increasingly important. While harder to measure, the Office for National Statistics (ONS) has developed measures for these intangibles.

Notably, ONS data for 2022 showed UK investment in intangibles far exceeded that in tangibles. The issue? Measuring investment solely by monetary value or GDP share assumes all investments yield equal future rewards. However, returns vary widely – for example, R&D may deliver higher returns than machinery. Ideally, we’d measure investment quality, not just quantity.

What influences investment in the UK?

There are several factors affecting the UK’s levels of traditional business investment, many of which are interconnected:

1. Business costs and taxation: The most obvious deterrent to investment in the UK is the cost of making and maintaining that investment. Expensive land, materials, and wages can discourage investment, especially if firms can relocate to lower-cost regions.
   
   Rising taxes, such as the increase in Employers’ National Insurance contributions, add to the burden. As Ben Jones, the Confederation of British Industry’s lead economist put it, higher taxes will “trigger a more cautious approach to pay, hiring and investment.”

2. Policy and economic uncertainty: While Brexit likely discouraged UK investment and complicated European market access and staff recruitment, this uncertainty is now eclipsed by the more erratic policymaking of the second Trump administration.
   
   The U.S. crackdown on immigration could significantly raise labour costs in some industries. But the greatest uncertainty comes from U.S. tariffs on imports and materials. These tariffs, aimed at boosting domestic investment, have raised costs and made profitability harder to predict. For context, in April, only 18% of U.S. small businesses planned to invest according to the National Federation of Independent Businesses – the lowest since the pandemic.

3. Access to finance: The U.S. has historically benefitted from huge share and bond markets and the dollar’s status as the global reserve currency – a status former French finance minister Valéry Giscard d’Estaing described as an “exorbitant privilege”. One of the benefits is that it suppresses borrowing costs for U.S. government and companies.
   
   Over the past decade or so, market-leading tech companies listed on U.S. stock markets have attracted significant overseas capital. These markets help companies raise funds for new tangible and intangible investments.
   
   The Trump administration, however, blames those capital flows for persistent trade deficits, seeing the “exorbitant privilege” as a curse. Its actions on trade deficits, threats to tax foreign income, and disregard for global norms, are now discouraging investment.
   
   This creates an opportunity for the struggling UK stock market, which has struggled with a declining influence, to stage a revival.

4. It’s what we do: The UK’s service-orientated economy means less tangible investment is required than manufacturing-heavy peers in the G7. While this isn’t necessarily a problem, it skews the UK’s investment profile. So maybe the trend of weak investment is less of a problem than people think, and it could be about to change…
   
   Artificial intelligence (AI) promises to make services more efficient than before. Agentic AI (systems designed to act autonomously with limited human intervention) can perform tasks faster and more accurately than humans, with fewer employees using multiple AI agents. UK-listed RELX, for example, is advancing this development and expects legal, scientific and medical R&D costs to plummet as a result.

5. The productivity puzzle: The UK has experienced a prolonged period of weak productivity growth, which is an indication that it may not be investing enough, or well enough.
   
   Alternatively, the lack of investment may reflect the lack of productivity – it may be the symptom not the cause. Regardless, boosting both investment and productivity remains essential.

Lessons from abroad: What other countries are doing right

Other nations have interesting policy approaches that could inform the UK’s strategy. For example:

• France offers generous R&D tax credits, encouraging businesses to innovate.
• Germany has outlined ambitious plans for investment in infrastructure and the low-carbon transition, laying a foundation for future growth.

What can the UK do?

The UK faces challenges in boosting its attractiveness to investors. However, targeted reforms and innovative solutions could unlock growth and build a stronger investment environment.

Tackling the housing challenge

Housebuilding is one of the most obvious shortcomings of the UK in recent years. A lack of affordable housing increases the costs of attracting and retaining employees, which hinders economic activity. To address this, the government has vowed to build 1.5 million homes over five years by easing planning restrictions and introducing financial incentives for new housing developments.

While housebuilding will take time, data highlight the challenge, with new homes approved in England in the year’s first three months at a 13-year low.[1] Planning system reforms are welcome, as housebuilding is vital for economic growth.

Supporting innovation and retaining high-growth companies

The UK boasts world-leading universities and excellent funding schemes like Venture Capital Trusts and Enterprise Investment Schemes, which encourage investment in domestic businesses by providing investors with significant tax breaks. However, although successful, their complexity has limited broader adoption.

Retaining fast-growing companies is another challenge. As businesses scale, they often seek public listings or private funding in markets with favourable regulatory and financial environments. Heavy taxation on profits or resources, like staff, can deter companies from staying in the UK.

The government should create a regulatory environment that protects consumers while reducing burdens on businesses. Striking the right balance – safeguarding investors and encouraging companies to list domestically – can help retain high-growth businesses. The U.S., for example, has adopted a more lenient regulatory approach, attracting many such businesses.

And while the UK ranks eighth in the World Bank’s Ease of Doing Business Index, access to credit is surprisingly weak for a country with a heritage as a financial centre.

Strengthening the UK’s capital markets

Healthy capital markets are essential for encouraging business growth and investment. Yet new listings on the London Stock Exchange have dried up with a trend of multinationals re-listing in the U.S., seeking the deeper pools of U.S. investment capital.

Proposed solutions include consolidating pension funds to boost UK infrastructure investment and reopening the UK corporate bond market to retail investors, which will provide better access to credit. Expanding mainstream ISA powers could also drive greater participation. However, debate persists on whether their tax benefits should mandate preference for UK-listed investments or allow investors to seek the best returns freely.

Our duty is to our clients, which is why we’ve often invested outside the UK, where returns have been stronger. Ideally, this conflict wouldn’t exist, and UK markets would thrive while supporting British businesses. But achieving this is challenging, especially with the draw of Silicon Valley and U.S. capital markets. 

The UK’s 0.5% tax on share purchases, while not a significant revenue source, instantly makes UK markets less competitive globally. Reducing or eliminating this tax could attract more investors and companies.

A case for cautious optimism?

The UK’s investment story is more nuanced than headlines suggest. While traditional measures may indicate under-investment, significant spending on intangible assets paints a more complex picture. The UK remains an attractive destination for investment, but rising business costs could become prohibitive.

Relatively simple measures could enhance the UK’s appeal to investors. Importantly, after years of Brexit-related uncertainty casting the UK as an investment pariah, the U.S. is now grappling with its own populist challenges. Indications suggest companies are becoming more cautious about investing in America. And given the relative size of the economies, even a small shift in preference towards the UK could significantly boost its fortunes.

So, there are things the UK could do, some straightforward and others more challenging, to emerge stronger, more innovative, and more competitive on the global stage. As your investment managers, we’ll continue to navigate this evolving landscape to protect and grow your wealth – ensuring you’re prepared for whatever the future holds.

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[1] Home Builders Federation

The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. You should always check the tax implications with an accountant or tax specialist. Neither simulated nor actual past performance are reliable indicators of future performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.