In the latest issue of the Deloitte Economic Review, our Economic Adviser, Roger Bootle, looks at whether companies are ready to take over as the economy’s next big spenders, now that consumers and the government are no longer able to bear the burden of driving economic growth. His main points are as follows:

• The corporate sector will not be able to offset the continued weakness of the consumer sector for four main reasons.
• History is not supportive - the corporate sector has never provided much of an offset to a weaker consumer sector during previous consumer slowdowns. Indeed, corporate spending has often fallen at the same time that consumer spending has been weak. Admittedly, it might be different this time round, with firms close to exhausting their spare capacity they may need to increase their investment and employment if they want to meet any rise in demand, which is likely to come predominately from abroad.
• But the second reason why overall economic growth is likely to remain weak is that firms might yet meet any extra demand without spending more money. Indeed, a rise in productivity would allow them to raise output without having to hire any more workers. Or firms could just choose to run down their stocks, given that these are currently slightly above normal levels.
• Third, firms’ inclination to spend their way through the consumer slowdown is likely to be constrained by the ability of the corporate sector to finance such spending. Profits growth is set to undergo a cyclical slowdown, while firms’ pricing power will continue to be squeezed as globalisation extends its reach yet further. We expect real profits to fall before too long. 
• Finally, although firms have spent the last five years or so restructuring their balance sheets – meaning that they are now better placed to borrow than at any time in the last few years – concerns about how they will finance spending become immaterial if companies decide that they simply do not want to spend more money. This seems likely due to the uncertainties they face regarding the outlook for demand, the tax regime and the regulatory burden. Indeed, given these uncertainties, if firms do decide to invest, they might well decide to do so outside of the UK.
• Overall, the corporate sector certainly looks in better shape than other parts of the economy and should start to increase its contribution to economic growth over the next year or two. However, enough obstacles remain to prevent it from providing the economy with quite the spending boost it needs given the degree of the slowdown in the rest of the economy.
• Consumers, in particular, will continue to tighten their belts as the economic drivers of household spending remain weak. The stimulatory effect of lower interest rates will be partly offset by further rises in household debt. Meanwhile, unemployment now seems to be on an upward trend, while the housing market continues to slow. And if all that were not enough, the prospect of tax rises – if not next year, then not long after – continues to loom large on households’ horizons.
• The rest of the world economy might provide some support. Although global growth as a whole in 2006 is likely to see a US-led slowdown as the large imbalances unwind, the euro-zone – the UK’s biggest importer – should see a modest improvement.
• Overall, though, the external sector is unlikely to compensate fully for the slowdown in domestic demand. We continue to expect GDP growth to slow to around 1.7% this year, from 3.2% in 2004, before showing only a modest improvement in 2006. Although the rise in oil prices could yet push consumer price inflation up further, there are few signs of any second-round effects, with average earnings growth remaining contained.
• As such, the Monetary Policy Committee will be free to cut interest rates to 3.5% by the middle of next year in order to support economic activity. Lower interest rates should also prompt the pound to drop, benefiting net exports. By 2007, we therefore expect economic growth to recover to around 2.5%, closer to its trend growth rate of 2.7% or so.

Ends

Notes to editors
This press release has been prepared by Roger Bootle, Economic Adviser to Deloitte.  If you have any questions regarding the views in it, please contact Roger Bootle directly on 020 7823 5000 or via email on business@capitaleconomics.com.

This press release contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte & Touche LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

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