Iain Clacher and Con Keating

Over the past ten years, according to Yodelar, the average returns of the Investment Association (IA) fund sectors were led by the Technology and Technology Innovation sector, amounting to a total return of 365.29%, a compound annual return of 16.6%.

By contrast, the IA UK All Companies sector averaged just 70.21% over the decade, a compound annual return of just 5.46%, the worst of all IA equity fund sectors.

While some of this lacklustre performance may be attributed to the effects of the well-known disinvestment by UK pension funds from UK equities, it is perhaps surprising then that the IA gilts sector produced a negative average total return of minus 1.43% over the period.

Even the IA UK index linked gilts sector, a market which is heavily dominated by pension funds, produced a total return of just 3.47% in nominal terms over the decade. The IA sterling corporate bonds sector produced a total return of 24.06%, an annual spread over gilts of 232 basis points.

This overall lacklustre performance needs some explanation, particularly as the Chancellor is exhorting us to invest in ‘productive’ assets in the UK, with the expectation that this will be largely through public and private equity.

The issue is of low productivity of the UK is one of both absolute and relative performance, and not one that will be easy to fix.

A prime candidate as an explanation has been the rising labour share of GDP, a trend that has been evident in the UK since the mid-1990s, which of course reduces the share of GDP available to capital and the gross operating surplus of companies. This trend is uniquely British, at least in magnitude.

Figure 1, shows the evolution of the labour share of GDP in the UK and a number of other developed nations. Only France shares the characteristic of labour share having risen over the period, but by just 1.08%, a small fraction of the 8.17% increase in the UK. The US labour share has fallen by 9.84%.

Figure 1: Evolution of Labour Share of GDP 1995 – 2023

Source: ONS

The elements of this growth in labour share are informative. Figure 2 show the evolution of both the wages of employees and their employers’ social costs, such as pensions and national insurance contributions. It is notable that these costs of employee social benefits (CoE: Social Benefits) has risen more than any other factor, by 5.18% annually. Gross Value Added (GVA) has risen by an average annual rate of 4.15% while wages and salaries (CoE) have risen at a rate of 4.37%, and overall labour income by 5.45%, while the gross operating surplus (GOS) has increased at a rate of just 1.8% annually.

Figure 2: Components of Gross value Added

Source: ONS

According to the ONS, the growth in social contributions may be explained as follows:

“Several factors may have contributed to the large increase including:

• an increase in the participation rate in workplace pension schemes from 47% in 2012 to 79% in 2021 after the phased introduction of auto-enrolment between October 2012 and April 2018;
• payments of deficit reduction contributions to reduce the shortfall and risk in employer-sponsored pension funds;
• higher contribution rates of employer National Insurance contributions (NICs), changes in income thresholds, and the phasing out of rebates for employers offering “contracted out” pension schemes.”

Against this background it seems likely that the wage settlements with doctors and rail workers, together with the budget changes to minimum wages and more importantly, employer national insurance contributions will result in even more growth in the labour share of GDP, and in the absence of exceptional growth in productivity in the UK, and an even lower gross operating surplus.

Of course, this makes the UK far from attractive as an investment proposition. It would also help to explain the exceptionally low confidence in business prospects expressed by business leaders in recent CBI surveys. Coupled with the announcement that the Pensions Review is now on hold , due to concerns about additional costs to business, these factors highlight the extent of the challenge faced by government.