One of the great disappointments of the weak economic recovery has been the sluggish revival of business investment — spending on new buildings, factories, equipment and intellectual property (mainly research and development, and software). For the United States, this spending in 2014 was about 9 percent above its 2007 record high. Sounds good? It isn’t. The average annual gain is a bit more than 1 percent over the past seven years. It is only a small stretch to say that capital has gone on strike.
Why? Can anything be done about it?
We now have a new study from the International Monetary Fund (IMF) that suggests some not very encouraging answers. For starters, it confirms that the investment bust is a global phenomenon. It’s not just the United States but also Europe, Japan and most advanced countries. As important, the main cause of the investment slump is clear-cut: Businesses aren’t expanding because they can already meet most demand with existing capacity.
Compared with what had been expected, the shortfall is huge. The IMF looked at predictions in 2007 of future investment and then examined what had actually occurred. For advanced countries, the difference averaged about 20 percent from 2007 to 2013. Investment was about one-fifth less than had been anticipated.
There was some difference between advanced countries that experienced banking crises (the United States, the United Kingdom, Ireland and Spain, among others) and those that didn’t (including Japan, Canada and Australia). The crisis countries suffered a drop in investment spending — again, from earlier expectations — averaging 22 percent, while the decline for countries that avoided banking crises was 16 percent. This implies that the recessions in countries with banking breakdowns were deeper than in other countries or that banks in these countries were less prepared to lend after the crisis — or both.
What’s more interesting is how much investment spending now is behaving as it has in the past. Historically, investment spending during recessions falls by two to three times the percentage of the economy’s overall decline, the IMF said. The pattern held in the Great Recession, but because the economic decline was so much greater, the effect on investment was also greater. In earlier slumps, investment fell only 10 percent, about half the level this time.
“Business investment has deviated little, if at all, from what could be expected given the weakness in economic activity in recent years,” the IMF concluded.
The result is a vicious cycle: A weak economy inspires lackluster investment, and lackluster investment perpetuates a weak economy.
Could we jolt business investment from its lethargy? The IMF suggests that more economic “stimulus” (a.k.a., bigger budget deficits) would boost business investment by shrinking excess capacity. Perhaps. But it’s also possible that temporary stimulus plans — as most are — wouldn’t generate much more private investment precisely because corporate managers would see them as fleeting. Why expand to serve demand that won’t last?
A more plausible prospect is that, if the recovery proceeds, surplus capacity will gradually shrink and persuade many companies to grow. Stronger investment could give the worldwide economy a much-needed second wind. This is either a silver lining in a dark cloud — or wishful thinking.
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