01/09/2014 17:33 BST | Updated 01/11/2014 05:59 GMT

Britain Needs to Invest In Itself

For many years there has been a worrying lack of investment in the UK. In fact, when all things are taken into account, the UK is investing almost nothing in its economic future. The Coalition government may have conjured some temporary growth, but this will disappear without much more new investment and if we want to avoid long-term decline we need to act right now.

The hard fact is that productivity growth in the UK has ground to a halt and there's a very simple reason for this: the UK, for the first time since the start of the Industrial Revolution, has virtually stopped investing in the type of economic activities which are capable of delivering increases in output per head of the population.

In 2013, the proportion of UK GDP devoted to gross investment was 14%. This is one of the lowest ratios in the entire world, as a survey in 2012 of 154 countries showed. The UK then ranked at number 142 - equal with El Salvador. By comparison, the world average is just under 24%. In China the ratio is just over 46%.

Depreciation - also called capital consumption - then has to be deducted from the gross percentage. This is currently running in the UK at just under 11.5%, leaving a margin of 2.5%. This might allow some net investment per head of the population if the number of people living in the UK was static, but the UK population is actually growing at about 400,000 per year. With about £120,000 worth of accumulated assets per head, such as roads, schools, hospitals, machines, factories, housing, all of this 2.5% and more is needed just to stop this accumulated capital being diluted down. The result is that there is no net new investment per head of the population now taking place in the UK at all.

Ever since the start of the Industrial Revolution, output per head has increased every year because the labour force was provided with new capital equipment - mainly machinery of a wide variety of different types - which continually increased the output that could be achieved per hour worked. The major problem, heavily exacerbated by our overvalued currency, is that there is no significant investment taking place where it is really needed to reverse this decline.

Manufacturing is in fact of key importance to the viability of our economy for three main reasons. First, it is far easier to achieve productivity increases in manufacturing industry than it is in the service sector, as all the statistics continually show. Secondly, manufacturing produces much more high-quality and high-income skilled blue-collar jobs than is the case in the rest of the economy. It also produces them with a far better geographical spread than is the case, for example, in financial services which are heavily concentrated in the South East of England. Most important of all, however, is the role that manufactured goods play in enabling us to be able to pay our way in the world - or to fail to do so as has been our lot now for many decades. The last time the UK had a foreign payment balance was in 1983 - now over 30 years ago.

The huge importance of manufacturing in making everyone in industrialised countries better off has been partly obscured by the huge falls there have been in the cost of manufactured goods - compared with services whose costs have generally tended to rise. This relative price effect makes the contribution of manufacturing to raising living standards more difficult to see, as in money terms the proportion of GDP derived from industry has trended downwards everywhere. Manufacturing, however, is still very largely the key to economic growth and more and more applications of IT to manufacturing processes are currently providing a further boost to increases in output per head - but only where investment in this type of technology is taking place. It is happening here and there in the UK but on nothing like a sufficient scale.

This is why productivity in the UK is static. There may be a small pick-up in business investment in the UK at the moment but too much of it is going into building office blocks and opening new restaurants. Almost none of it is going into where it really needs to go - into light industry, exporting and import substitution. Of course we need to improve our infrastructure and we need investment in services, but the returns to the economy as a whole for investment in these areas is typically quite low - of the order of 10% per annum. Contrast this with the total returns achievable in manufacturing - including higher wages, better products and more tax revenues as well as increased profitability - where the total returns can easily soar to 50% or more per annum. It is only investment on a big scale in this part of the economy which will deliver significant increases in output per head and thus get the economy growing again on a sustainable basis.

There is therefore no puzzle about why productivity is static in the UK. It is because we are not investing in the plant and equipment which can deliver it. Until we do, we are going to be stuck with a stagnant economy and static or falling living standards. Not a great result for the nation which invented the Industrial Revolution in the first place.