Valentin Boboc is a Senior Economist at the Institute of Economic Affairs.
London businesses seem to be struggling with an odd combination of high business costs and low demand for their goods and services.
According to a recent survey by the London Chamber of Commerce and Industry (LCCI), more than half of London businesses are facing rising fuel and energy costs. Nearly one in four (23 per cent) are facing rising labour costs, enough to make them increase their prices. These figures are down on the previous quarter, but the survey nevertheless suggests that many businesses in the capital are finding the cost of doing business rather prohibitive right now.
At the same time, the survey shows that domestic sales are weak. Some 29 per cent of businesses reported falling domestic sales over the previous quarter, compared with 13 per cent reporting growing sales. Similarly discouraging figures apply to export demand for firms with overseas clients.
Immediately after lockdown ended, the economy seemed to be characterised by shortages. Businesses wanted to expand, but found it hard to get the people or inputs they needed to do so. The Bank of England spoke of strong hiring intentions and acute recruitment problems in 2022, and there were around 1.3 million job vacancies in Britain in spring 2022.
But now the picture is very different. Almost two-thirds (64 per cent) of businesses said they were not operating at full capacity. Only 10 per cent of businesses tried to recruit new staff in the previous quarter, and only 5 per cent were successful in increasing their workforce. By contrast, 12 per cent reduced their workforce.
In other words, rather than a shortage economy, London seems to have become a ‘surplus economy’. This surplus does not prevent there being shortages of particular inputs, such as skilled workers, and larger firms were much more likely to have tried to recruit than micro-businesses. But overall, there is more capacity than can be profitably employed.
Weak demand and high costs form a dangerous combination. Businesses find it hard to raise prices, because that will reduce demand still further. But if they don’t raise prices, high costs will reduce their profit margins, leaving them with less to reinvest in the business. And unless they cut costs by other means, such as reducing their workforce, they will find it hard to recruit, because each new recruit will add to their already high costs and may be difficult to employ profitably.
This pincer movement risks taking the economy to a new, lower equilibrium point, with businesses investing less, recruiting less and buying less from their suppliers. Over time, some businesses may be forced to close, or at least cut back, destroying productive capacity and reducing productivity growth still further.
The survey is, of course, not all doom and gloom. For example, certain larger firms are still managing to expand, and overall pessimism eased considerably compared with the previous quarter.
However, the survey does suggest that policies to reduce the costs facing businesses need to go hand in hand with policies that reduce the cost of living for consumers. Otherwise, the economy risks settling at a new, lower equilibrium.