2016 preview: productivity gaps remain as sector set for growth

Denise Chevin
12 January 2016

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The market

The fortunes of our industry are inextricably linked to the strength of the economy. ACE economist Bill Simpson considers the trends, challenges and risks

The trends

Economic indicators reveal many positive trends for the year ahead – and some surprises. Company profits have been rising year-on-year since late 2012,but fell slightly in the third quarter of 2015 when compared against high marks a year earlier. This year-on-year increase should resume for the fourth quarter, when the data is revealed.

Company profit margins in our sector, based on UK firms participating in ACE Benchmarking 2015, improved from 5.4 per cent in 2013/14 to 7.2 per cent in 2014/15, and are forecast to continue growth to 8.3 per cent.

Thanks to the rise happening in real wages, consumer spending – the largest share of national expenditure – should see strong growth in 2016.

Additionally, corporate investment,which has grown steadily for two-and-a half years, should continue to rise.

Economic indicators for 2015 reveal increasing scarcity of labour as well as the need to boost output per head,which together signpost an increased capital intensity.

Net trade in 2016 – exports minus imports – will lessen economic demand as many European trading partners are growing at a slower rate, while UK imports are likely to be buoyed by an increasingly strong consumer spending.

UK inflation is zero, balancing slightly over 2 per cent for the rates of both deflation in goods and inflation in services. Yet it should be noted that at present the international economy is helping to bear down on these prices.

Surprisingly, the 18-to-64-year-olds labour force inactivity rate – numbering those not active as workers or job seekers – was in 2015 the lowest since the late 1980s, reinforcing that the UK economy now has strong employment and a competitive environment for firms that are recruiting.

Analysis reveals another surprise, in that productivity growth is seen to have become separated from what it normally drives – economic growth.

Real economic growth per head has been rising at a rate about 0.6 per cent slower than the rate of real economic growth over the past four quarters.

While people have been added to the production process, now the emphasis must shift to producing more per head.

Challenges

Skills shortages are the big worry that will carry over from 2015 to 2016. While this is already a serious concern in our sector, the worry is spreading across other sectors. In order to monitor this, the Bank of England will watch earnings growth and be prepared to nudge interest rates higher if the shortage of  labour spurs any acceleration in wages.

Risks

Insolvency trends for 2015 provide positive news for the UK economy. The DTI Insolvency Service reports the lowest level of compulsory company liquidations since 1989 and the lowest percentage ratio of company liquidations in comparison with the register of active companies since records began in 1984.

Late payment continues to be a risk as a predictive factor for financial difficulties. However, ACE Benchmarking showed improvements, as year-end debtor days for all firms fell from 78 in 2013/14 to a still-high 75 in 2014/15, and the yearly average slid from 79.5 to 74.7. It also showed the share of trade devoted to a firm’s three largest clients averaged only 15 per cent, which does not flag up insolvency risk.

Annual growth in productivity for the whole economy rose to 1.1 per cent in the second quarter of 2015, from 0.4 per cent a year earlier, and should continue to improve in 2016. However, this brings potential risks. In particular, as the UK runs low on the skills needed to fill vacancies, productivity will have to improve or else growth in real GDP will at some point start to slow.

A fair wind

The ACE Benchmarking report for 2015 revealed positive improvements for ACE members’ revenue per fee earner and staff number measures of productivity,fostering an expectation of growth. Despite the challenges and potential business risks in the UK’s economic landscape, I believe productivity and investment will strengthen: the outlook is good for continued growth in 2016.

We should see the economy grow by about 2–2.5 per cent in 2016 and 2017.