Businesses Scale Back Investment in America

Pessimism about growth holds down spending more on factories and equipment. But the reverse also is true.

More might be better, but is it needed?

Photographer: Krisztian Bocsi/Bloomberg

Many economists and pundits take it on faith that weak business investment is a bad thing. It’s well known that over the course of the business cycle, investment varies more than other parts of the economy, such as consumption. So if investment is low, it may mean the economy is still suffering the lingering effects of recession. But if investment declines over the long term, it could imply at least two bad trends -- either businesses don’t see many good opportunities, or society is becoming more short-termist in its thinking. For these reasons, most economists see falling business investment as a problem to be solved.

On one level, the evidence is pretty clear: Net of depreciation, privately held American businesses are only investing about 2 percent of the country’s gross domestic product in the U.S. itself:

Not Much of a Comeback

Net private domestic investment as share of GDP

Source: Federal Reserve Bank of St. Louis

This situation has persisted since the turn of the century. Gross investment, which includes replacing depreciated capital, has been little-changed from its long-term trend:

Maintenance Mode

Gross private domestic investment as share of GDP

Source: Federal Reserve Bank of St. Louis

But it’s worth asking why companies are merely maintaining what they have instead of building lots of new factories and buying new equipment.

In a pessimistic research note, Srinivas Thiruvadanthai of the Jerome Levy Forecasting Center asserts that companies aren’t investing because the future of the economy just doesn’t look very bright. One of his main pieces of evidence is industrial overcapacity. Capacity utilization, which is the ratio of output to an estimate of potential output, has been declining in the U.S.:

Sitting Idle

Total industry capacity utilization

Source: Federal Reserve Bank of St. Louis

That implies that companies aren’t even using all of the capital they have. Why build more buildings or buy more software when you’re not even using what you’ve got? Thiruvadanthai also notes that the estimated value of private assets is unusually high relative to total private value added, which implies that there’s a glut of capital sitting around not producing much of value.

One possibility is that this is being caused by a general shift from more capital-intensive to more labor-intensive goods -- i.e., from manufacturing to services. If people are relatively satisfied with the amount of cars and houses they have, but want more health care and education, it makes sense that capital investment would fall. However, employment isn't particularly high relative to 10 or 15 years ago:

Still Climbing Out of a Hole

Employment population ratio, 25-54 years of age

Source: Federal Reserve Bank of St. Louis

So it looks like there’s both unused capital and unused labor sitting around. If the shift to services were responsible for weak investment, we’d expect hiring at hospitals and schools to more than outweigh declining employment in factories. And we’d also expect labor demand to push up wages. But neither employment nor wages has been particularly strong in recent years.

Thiruvadanthai, noting that investment is usually a good predictor of economic growth, pessimistically concludes that weak investment is a perfectly rational response to expectations of slow growth.

High price-to-earnings ratios on U.S. stocks would seem to contradict Thiruvadanthai’s pessimism, since expensive stocks are usually believed to signal prospects of strong earnings growth. But recent economic research indicates that high profits -- and therefore high valuations -- are likely due to monopoly power rather than to capital becoming increasingly valuable. If investors expect monopoly power to persist or even to increase, that would naturally tend to push P/E ratios above their long-term average. Thus, expensive stocks should give us only slight reason for optimism.

So Thiruvadanthai might be right that everyone expects slow growth. Certainly, slowing growth in population and educational attainment are headwinds for the economy. Some economists also suggest that technological progress is stagnating, or that the economy is trapped in endless recession. Pessimism about the global political climate might also play a role.

One final alternative, which I haven’t seen many people suggest, is that the direction of technological progress is becoming less predictable with time. If companies don’t know whether their capital investments will be rendered obsolete by the next cool new app or machine-learning algorithm, they will be unlikely to take the plunge and invest, even if the technological future looks bright. This possibility deserves more study.

If Thiruvadanthai is correct, then the government can’t and shouldn’t do much to prod businesses to invest more, beyond just trying to increase economic growth. But governments are always trying to increase growth anyway. And if weak investment is purely a function of rational pessimism, rather than short-sightedness or some inefficiency in the financial system, then leaning on corporations to invest more for the future would be an exercise in futility, and possibly even a waste of society’s resources. Perhaps economists are wrong to think of weak investment as a separate problem from the overall challenge of slow growth.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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