Britain has emerged from the pandemic with a baby business boom rather than zombie firms – but with no upturn in investment

British businesses have emerged from the pandemic with higher cash reserves and, rather than being plagued with zombie firms, the corporate sector has been rejuvenated with high rates of firm creation. The UK must now use this moment to turn around its poor record on productivity and investment, according to new research from the Resolution Foundation published today (Wednesday).

Bouncebackability – the 21st report for The Economy 2030 Inquiry, a collaboration with the LSE, funded by Nuffield Foundation – examines how the Covid-19 pandemic affected British firms, and what this means for the country’s long-term economic outlook.

The Foundation notes that the sheer scale of the pandemic crisis – which saw the UK experience the sharpest economic contraction in a century – left many people fearing that it would cause significant damage to businesses, with a return of the debt-laden, low-growth ‘zombie firms’ that marked the post-financial crisis period.

However, its research shows that the pandemic was less detrimental for firms than anticipated – and compared to previous recessions in the UK – in large part due to government intervention, with 80 per cent of larger firms utilising the Coronavirus Job Retention Scheme (CJRS) at some point.

This support, coupled with wider business support schemes, helped firms to boost their cash reserves to the highest level on record – reaching 28 per cent of GDP by March 2022, up from 20 per cent at the end of 2019. And while the corporate debt stock has risen – from 71 per cent of GDP in 2020 to 75 per cent in the most recent data – it is currently 15 percentage points lower than the peak during the financial crisis (90 per cent in Q4 2008).

Strikingly, firm creation wasn’t dented by the pandemic, with the shift to online retail key to driving firm births. Compared to pre-pandemic levels, there were 67 per cent more firms created in the transport sector in 2021, 45 per cent more in the wholesale sector and 34 per cent more in the retail sector. This trend has continued into 2022, with the number of firm births in the first quarter of this year 20 per cent higher than its pre-pandemic level.

Although it is unclear how long this trend may persist, this surge in firm creation is a good sign for the economy, says the report author, as new firms tend to have higher productivity growth rates than established firms. The creation of new firms also helps to reallocate resources towards growing sectors of the economy.

The other big hope for a post-pandemic productivity boost comes from the growth in hybrid working, which has seen one-in-five workers now mainly working from home (WFH).

However, the report finds that there is little evidence so far that WFH has led to a substantial rise in productivity, although it can bring other benefits. Just under half of firms (47 per cent) anticipate that WFH will improve productivity, but four-in-five (80 per cent) larger firms are facilitating WFH in order to improve staff wellbeing.

And while pandemic scarring has turned out to be less of a concern for business, the pre-pandemic concern of low investment – which has become particularly embedded since the EU referendum in 2016 – remains a huge challenge to overcome. Despite the economy exceeding its pre-pandemic size in 2022, business investment is still over 9 per cent below its peak.

The report finds that economic uncertainty was the most common individual reason for firms to limit capital expenditure. Firms were four times as likely to cite economic uncertainty than the more traditional post-recession reason of an inability to raise external finance (17 per cent compared to 4 per cent).

The Foundation says that managing businesses’ fears of uncertainty, which the Government can assuage through a thorough and well-articulated economic strategy, as well as policies that encourage investment, will hold the key to getting more private sector firms to invest.

It adds that the Chancellor has identified the UK’s business investment challenge in recent speeches to both the London Business School and the CBI, and suggested that reforming business taxation could form a key part of the Autumn Budget this year.

But with the cost of living crisis creating increased uncertainty for prices, a higher risk of recession, and a massive fall in consumer confidence, encouraging businesses to invest their pandemic profits now will prove a difficult task for policymakers, says the Foundation.

Jack Leslie, Senior Economist at the Resolution Foundation, said:

“Despite initial fears that the pandemic could spark a fresh wave of ‘zombie firms’, Britain has instead emerged from this crisis with a baby business boom, and with firms holding the highest cash reserves on record. This puts them in the perfect position to face up to the UK’s persistent challenges of low productivity and investment in the coming decade.

“But, while the pandemic induced more flexible and innovative working practices, these don’t appear to have boosted productivity so far. However, the high rate of firm creation does offer optimism that new businesses can help drive productivity growth in the future.

“The outlook is less positive for investment, with firms put off investing by the high economic uncertainty which remains post-pandemic, despite their strong financial position. With the cost of living crisis set to continue for months – or even years – policymakers will need to think creatively about ways to inspire investment.”