BUSS4 Example Essay - UK Economic Environment

Here is an example essay for BUSS4 students - this one is for Section B on the UK economic environment.

QUESTION

In your view, is the economic environment favourable for UK businesses at the moment?

INTRODUCTION

Economic conditions change constantly and at any one time there will be positive and negative economic factors for UK businesses depending on the nature of their business and industry. However, an assessment of the overall economic environment can look at some major indicators to see whether they are favourable or unfavourable. In this essay I will examine three: GDP growth, interest rates and inflation.

A reason why the economic environment is now favourable for UK businesses is that economic growth (as measured by GDP growth) is positive. This line of analysis is based on the importance of economic growth to all major business sectors. GDP measures the overall value of economic activity in an economy, including consumer spending, business investment and government spending. Economic growth is therefore an important indicator of how favourable overall economic conditions are. In recent years the UK economy has slowly recovered from the recession (when GDP fell significantly) that followed the global financial crisis in 2007-9. The recession was highly unfavourable for many UK businesses and it led to many reducing production capacity, cutting investment and losing jobs as strategies for survival. The subsequent improvement in GDP growth, whilst relatively slow, has proved sustainable and there has been a steady improvement in consumer and business confidence despite cuts in government spending. An example of a UK business that has benefited from favourable economic growth is Dominos UK who have significantly increase revenues and profits partly as a result of stronger consumer spending. Dominos UK increased revenues by 16% in 2015 to £877m following from strong growth in the previous year and profits increased by 17%. Dominos has used the confidence from rising consumer spending to accelerate its store opening programme, adding 60 new stores in 2015. Not every retailer performed so well in 2015 though, highlighting how performance can vary even in favourable conditions. Dominos performance can be contrasted with John Lewis who suffered a 10% fall in profits in 2015 as a result of intense competition. Linking back to the essay question, it is obvious that a return to positive economic growth at this stage of the business cycle is good news for most UK businesses, though the overall impact of GDP growth is just one factor affecting business performance. Businesses that are struggling to compete for other reasons (such as a cost disadvantage) will not benefit so much from favourable GDP.

A reason why the economic environment is now favourable for UK businesses is that interest rates have remained very low for many years. The analysis for this point is based on the important role interest rates play in affecting economic activity of both businesses and consumers. The bank base rate helps determine the cost of borrowing for both businesses and households, and also influences the returns earned from saving. Consumers benefit from low interest rates if they have variable rate mortgages as their disposable income each month is much higher and they can afford to spend more. Businesses benefit if they have high levels of debt as the finance costs are lower thereby resulting in lower interest costs and higher profits and cash flows. The evidence for the UK economy must inevitably focus on the consistently low level of interest rates since 2009. When interest rates were cut to 0.5% in March 2009, few would have predicted that interest rates would have stayed so low right up to today. This 0.5% base rate has proved favourable for many UK firms, particularly those with relatively high gearing since very low interest rates have made it easier for them to finance their debts. An expectation that interest rates will remain low has also favoured firms planning significant investment. A good example is Jaguar Land Rover which in early 2016 announced plans to spend about £500 million on a new factory Coventry less than 12 months after a huge investment in Castle Bromwich. The benefits of low-interest rates on consumer confidence and spending are illustrated by data for UK consumer spending which reached an all time high of £295bn in the first quarter of 2016, making conditions even more favourable for UK businesses targeting UK consumers. Linking back to the essay question, whilst savers or businesses with large cash piles might disagree, low interest rates are generally good news for businesses and consumers alike as they help sustain positive economic growth. Of course some sectors like car manufacturing and retailing will find low interest rates more favourable than others, but few UK businesses would wish interest rates to start rising significantly.

A reason why the economic environment may not be favourable for UK businesses is that the UK economy has very low inflation and might even enter a period of deflation, which could depress business profitability and reduce investment returns. In terms of analysis, normally you might expect low inflation to be favourable for businesses since it influences wage costs and the prices of other inputs. If inflation is low then employees may have reduced expectations of wage rises which in turn may result in lower pressure for employers to offer pay increases. Similarly stable purchase prices from suppliers should enable a business to be able to maintain gross profit margins without having to pass on cost increases to consumers. However, low inflation is not necessarily good news for businesses. If selling prices are rising very slowly, it makes it harder for businesses to increase sales revenues other than by selling higher volumes, which in turn may make it harder to increase the absolute level of profits. Worse still, if an economy (or industry) enters a period of falling prices (deflation) then revenues and profits are likely to decline too. Looking at the evidence for the UK economy, it is clear there are some industries that are suffering from very low inflation or indeed deflation. The UK grocery retailing sector has struggled to handle price deflation, which has been partly caused by intense competition from low-priced competitors like Aldi and Lidl. The major supermarket retailers like Tesco, Asda and Sainsbury's have all commented publicly that price deflation has made trading conditions in their sector unfavourable. A market such as electrical goods retailing has suffered from deflation for several years, impacting the profits of all major retailers. Linking back to the essay, it might seem strange to argue that low inflation is unfavourable for UK businesses. However, the reason I have is that very low inflation poses a danger to UK businesses if it subsequently turns into deflation which might then lead the UK economy towards a period of much weaker economic growth.

Overall, my view is that the economic environment is relatively favourable for businesses in the UK at the moment. Whilst there will always be variation in economic conditions, the key economic indicators have improved in recent years and appear favourable. Economic growth has remained relatively stable at between 2 to 2.5% for some time now, which is a significant improvement on the sharp decline in GDP during the 2007-9 recession. Interest rates have remained very low since the start of 2009 and this has provided the kind of stability that businesses need in order to plan their investment, as well as helping households increase their spending. Of course, not every business or industry will describe their economic environment as favourable. Firms reliant on government spending in the UK or on GDP growth in key export areas such as the Euro Zone would doubtless argue that the economic environment is tough for them and their industry. Similarly, competitively-weak firms in most industries will still struggle despite relatively benign conditions. However the main economic indicators for the UK economy look as good as they have for some time and barring a significant external shock (such as Brexit) look favourable right now.