Starting New Venture in the UK - Case Study Example

Starting new venture in UK Current UK economic scenario GDP figures UK has slowly been recovering from the recession of 2008 since the last quarter of 2009. However, the Q3 figure of 2010 showed that it was still 3.9% lower than the pre-recession period figures (pwcwebcast 2010). As per latest forecasts made by PWC the GDP will grow by 1.8% (average) for the year 2010 and 2% for the year 2011. Source: pwcwebcast (2010) Though the data above shows a modest recovery over the 2008 period, the expected fiscal tightening which will increase VAT to 20% from January 2011 can have a negative impact in the short term. Unemployment rate Unemployment rate in UK for people in the age group of 16 to 64 years stood at 7.7% for the Q3’10. This a major improvement over the 2008 figures during the same period. It also shows an improvement of 0.1% over the previous quarter (statistics.gov.uk 2010). Source: statistics.gov.uk (2010) The total number of unemployed people was at 2.45 million by the end of the quarter (statistics.gov.uk 2010). Most of the employment has been boosted by self employment. This shows that more and more unemployed people are finding small business opportunities for themselves and hence higher competition. Unemployment has a very negative impact on consumer spending as well as demand. As more and more people lose their source of income, the demand for goods falls as their purchasing power diminishes. Though there has been a slight improvement in the figure, this does not look like a very promising number looking at further fiscal tightening road map of the government. A positive aspect of high unemployment for a new venture is easy availability of labor. If there is low unemployment, businesses have to increase wages to obtain manpower. Productivity Unit wage costs for the country are going down and the productivity is increasing. As per Keynesian theory, with some provisos, a decrease in money wages has a positive effect on aggregate demand in that, through the induced reduction in prices and the demand for money for the transaction motive, it lowers the rate of interest and favors investment (Rotheim 1998). This provides a positive scenario for a new business setup. With higher productivity and lower input costs there is a possibility of increasing output at low input prices. There is also a possibility of low interest rate scenario in the future. Source: statistics.gov.uk (2010) Inflation Looking at the inflation figures we can see that CPI is at 3.2%. Any increase in this figure indicates increasing prices. This is on the higher side as compared to EU’s total figure of 2.2% (statistics.gov.uk). The major contributors to this were lubricants and fuel and financial services which directly impact businesses. Source: statistics.gov.uk (2010) Producer Prices PPI (producer prices) were at 4% in October. Again materials and fuel were the major contributors. Consumer Confidence Index This index was again at a low after the announcement of austerity measures which include increase in VAT and personal taxes. The building society’s consumer confidence index fell to 56 in July as against 63 in June (Murchie 2010). This has a direct impact on spending as the consumers feel that their disposable income is expected to decrease in the coming months. Consumer spending There was some increase in consumer spending on account of the VAT increase deadline coming closer. People are buying heavily before the price rise but this is only a temporary phase. Inflationary pressures and increased taxes are bound to decrease spending in the coming months. Impact on new venture setup For a new venture the first and foremost thing is the arrangement of finance for the capital expenditure as well as the day to day operations. Looking at the economic scenario of UK, the bank rates are expected to remain low at least during 2011 (pwcwebcast 2010). However, in the long run (taking a 5year scenario) there will be an increase in the rates. Hence, for the short term it would be a good option to finance the new venture by debt. However, credit is still a scarce resource. This can also be seen from the fact that financial services are one of the major contributors to the increased CPI. A survey by EEF engineering group shows that during the two-month period (August and September), 31% of companies reported an increase in the overall cost of credit versus 34% previously while the cost of new borrowing rose for 37% of companies, up from 32% in the previous survey (Murchie 2010). But as discussed earlier, the interest rates are expected to reduce in the short run. High CPI and PPI are not positive indicators for a new venture. This only shows that the cost of manufacturing is increasing and the overall cost of goods is also on the rise. Under these conditions, it would be difficult for a new venture to produce goods at competitive prices knowing that the firm would take longer time to reach economies of scale. One very worrisome aspect for any new business is the high debt burden of the UK government. This creates a very volatile situation for a new venture. The total UK debt to GDP ratio is at 5.4 times the national income. At this rate the debt would stand at 9 to 10 trillion pounds (pwcwebcast 2010). At the current interest rates (which are substantially low), the burden is manageable. However, with increasing interest rates, on account of stricter financial regulations, the gross interest payments could increase to 8% (pwcwebcast 2010). This would decrease the spending power of the consumers. Thus, there will be reduction in demand for products and eventually reduced business opportunities. This will not only have a dampening effect on the spending power of the UK household, but also on the companies as their interest burden would increase drastically pulling the bottom lines further down. Now, a new venture may not be able to sustain this burden for long. The expected increase in VAT to 20% is for the time being considered as a major dampener. It has resulted in reduced consumer confidence and expectations of lower spending on account of higher inflation resulting in increased prices. However, an analysis by PWC suggests that effect of VAT on inflation would only be temporary, mostly in the first year of implementation. There would be a 1% impact on inflation, 0.2% reduction in consumer spending and around 0.13% reduction in GDP (pwcwebcast 2010). However, this impact would diminish over the next four years. The job loss predicted for 2011 on account of VAT increase would amount to around 38000 jobs. The following table shows the PWC simulation analysis. Source: pwcwebcast (2010) Thus, we can see that VAT increase is not going to have a very negative impact on the economy as a whole. On the other hand, if the government is able to use this inflow to reduce its borrowings, the overall interest rates would come down. Gross domestic output is also expected to be impacted adversely on account of fiscal tightening. As per the PWC estimates, business services will be impacted with 3.7% loss and construction by 4.5% (pwcwebcast 2010). Would it have helped new ventures had the British government not resorted to fiscal tightening at this point in time? In a simple Keynesian world, fiscal tightening has a negative impact on domestic demand and as such would contribute directly to the depth of recession (Collyns and Kincaid 2003). However, it is possible that though fiscal tightening is usually Keynesian, it becomes non-Keynesian during the crisis periods. This is because, when public borrowing decreases as a result of fiscal tightening, the general investor confidence increases and hence the interest rates reduce which in effect give a boost to consumption and investments. If the British government is able to cause this effect, the current stand on fiscal tightening can bring about a major recovery. Thus the overall long term impact of fiscal disciplining regime for new businesses would be positive if they plan with an aim of absorbing the stress for first year of implementation. They also need to plan for a double dip situation as there is a possibility of creating a Keynesian world scenario. Conclusion After having analyzed the various economic indicators of UK, it can be concluded that the country has already come out of the crisis phase and is marching forward with an aim of reaching the pre-recession levels. The various measures adopted by the government, if implemented in the right spirit, will yield positive results in the long run, though in the immediate future there will be a slight pull back. Hence, new businesses have an opportunity to start up their projects but should be ready for subdued results in the first two years. References Collyns, C and Kincaid, GR 2003, Managing financial crises: recent experience and lessons for Latin America, International Monetary Fund Murchie, K 2010, UK consumer confidence plunges to 15-month low, Finance Markets, viewed on November 25, 2010 http://www.financemarkets.co.uk/2010/08/11/uk-consumer-confidence-plunges-to-15-month-low/ Murchie, K 2010, Survey finds credit availability has not improved, Finance markets, viewed on November 25, 2010 http://www.financemarkets.co.uk/2010/09/20/survey-finds-credit-availability-has-not-improved/ pwc.co.uk 2010, UK economic outlook – November 2010, viewed on November 25, 2010 http://www.pwcwebcast.co.uk/ukeo_nov2010_summary.pdf Rotheim, RJ 1998, New Keynesian economics/post Keynesian alternatives, Routledge statistics.gov.uk 2010, UK snapshot, viewed on November 25, 2010 http://www.statistics.gov.uk/cci/nugget.asp?id=10 Read More