For some time now, you would have to have been living under a rock not to have a sense that the UK economy is most particularly challenged.
We are all painfully aware that we have a growth and productivity problem.
A survey from the Office for National Statistics at the beginning of this year found 87% of British adults were worried about the cost of living and 69% about the economy.
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UK public debt is running at not far off 100% of GDP. That is nearly £100,000 per household. The interest bill on this alone will cost us nearly £90 billion this year, more than we spend on education and nearly three times what we spend on defence.
What is particularly galling about this state of affairs is the extent to which arguably one of the single most important factors in causing it seems to get no airtime at all. That critical factor is the parlous state of the UK’s domestic stock market.
A huge part of the UK’s current economic malaise has to do with the extent to which we have effectively eviscerated our stock market since the 1990s.
This is incredibly poorly understood by most of the population and by the vast majority of our political class. So much so that the topic wasn’t even an electoral issue this year.
To give some evidence for this position:
In 2007, the UK had more than 3,250 companies listed on the London Stock Market. Today there are fewer than 1,800.
All too few people are aware that this has happened, even a good number of finance professionals and journalists, and seemingly vanishingly few of our politicians.
A generation ago the UK stock market was 10% of the value of the global stock market. Today it is 3-4% depending on how you calculate it.
Of 14 British biotech companies to float on a stock market since 2018, 12 of them did this overseas – primarily in the US. This matters because we have world-leading science and should be building stock market sized biotech companies.
Many of our other biggest companies now have their primary listing overseas, including BHP Billiton, CRH, Flutter Entertainment and plenty of others. Arm Holdings – the largest company the UK has built in a generation – is listed in the US. Hundreds of billions of value has left our shores.
Up to June of this year, money had flown out of UK active equity funds for 37 consecutive months.
Why has the UK stock market shrunk?
There are plenty of reasons why this has happened, but one of the most important ones has to do with the fact that our pension funds have stopped investing in British shares.
Italian shares make up around 0.6% of the value of global stock markets, but Italian pension funds have nearly 41% of their money invested in Italian shares.
Japan is about 4.4% of global equities, but more than 49% of Japanese pension assets are invested in their domestic market.
Even in the US, where fund managers have huge exposure to overseas markets, because they can afford to, 63.5% of American pension fund assets are still invested in American shares, as against the 43% that those shares represent as a percentage of global equities.
This is the case for most of the other developed countries in the world.
As Simon French, Chief Economist at UK stockbroker Panmure Liberum and regular Times columnist has put it: “Every major pension industry in the developed world is hugely overweight its domestic equity market – by an average of 2,089%. The UK is 41% underweight its own.”
British pension funds had more than 50% of their assets in British shares a couple of decades ago. Today they have somewhere between 4% and 6%, depending on how you calculate such things.
We are basically the only developed country in the world that has done this. The impact on the British economy has been horrific, because it has made building businesses in the UK very difficult and building large businesses not far off impossible.
Perhaps the most troublesome thing about this reality is that it has been largely of our own making. It has been the result of poor policy decisions and burdensome regulation.
The first cracks began to appear under Tony Blair and Gordon Brown in the late nineties when they abolished the dividend tax credit. In 2014, the OBR estimated that this had raised around £5 billion a year of tax, but had taken a cumulative £230 billion away from UK pension funds up to 2014. By now, the opportunity cost of this one policy decision has certainly been a multiple of that number.
Writing in the Sunday Times, leading British fund manager, Richard Buxton, pointed out that burdensome regulation of UK pension funds has prevented £1.5 trillion held in UK pension schemes from being able to invest in UK businesses, because of excessive risk aversion.
Why does this matter?
This matters enormously for the British economy and for British society.
British shares now trade on a 40-60% discount to shares in many other parts of the world.
This puts British companies at a huge commercial disadvantage; UK plc has to pay twice as much to raise money, whether to make acquisitions or fund their investment plans.
This is one of the key drivers behind so many of our companies choosing to list elsewhere and / or accept bids from overseas buyers, taking vast quantities of wealth, tax revenue, employment and intellectual property away from the UK.
Gordon Sanghera is the CEO of one of the few successful UK biotech companies. As he has put it: “A company is offered £500 million to be acquired by a US company and everyone cheers. But why don’t we say ‘no’ and go and get the top talent and say, ‘Let’s make it a £5 billion company.”
The impact of all of this is incredibly poorly understood because so few people understand how the stock market works and how “equities” are used to build businesses.
Too many people believe that British companies are undervalued because they’re simply not as good as companies elsewhere, such as the American tech names for example.
But this misses the vital role played by capital depth and a functioning stock market.
American companies now valued in the multi-billions and even trillions could never have got there had they had to cope with the funding environment faced by British companies for the last few decades.
This is a classic case of chicken and egg. If the UK had retained the £1.5 trillion or more of capital that has gone into bonds or been invested overseas, British companies would have been far better positioned for growth and expansion, and the economic benefits of that would have remained in the UK. The aggregate economic effect of this lack of capital has been profound, to put it mildly.
In 2021, smaller companies accounted for 61% of employment and more than 50% of turnover in the UK economy. Plenty of this comes from very small companies, such as a local restaurant or shop, but small, stock market listed companies, should be one of the core drivers of any economy – if you want growth at least.
Such companies should be creating massive economic value, employing millions, and contributing billions of tax revenue. Yet we have lost as many as 1,500 of them in fewer than 30 years.
This situation needs to be addressed urgently. After all, the first step towards solving a problem is admitting you have one.