Capital spending stays weak

The dearth of investment opportunities seems to be continuing. This week's figures show that business investment fell in Q3, despite the strength of the wider economy. This continues the long-term downtrend in investment as a share of GDP. Business investment accounted for 8.5 per cent of GDP in Q3. In the late 90s, it was over 12 per cent*.

Granted, this trend decline is in part due to a fall in capital goods prices, which means that a given level of nominal spending buys a lot more stuff. However, it's not clear that this is much comfort. It just raises the question: why - even in the good times - did companies not take greater advantage of falling prices to expand or upgrade their capital stock?

There are two things that are worrying here. First, investment was weak even before the recession; the fall in the share of investment in GDP began in the early 00s.

Secondly, this recession has seen capital spending clobbered even more than in the last one. Yes, investment has risen 4.6 per cent in volume terms in the last 12 months, which is better than we saw at the same stage of the 1990s recovery. But this is largely because it fell more during the recession. The volume of business investment is now 17.6 per cent below what it was when GDP peaked. At the equivalent stage of the 1990s cycle - that is, four quarters into the GDP recovery - it was only 12.6 per cent down from what it was when GDP peaked.

This is alarming because the 1990s recession was due largely to an over-accumulation of capital - firms borrowed heavily in the 1980s boom whereas they hoarded cash in the 00s boom. This should have caused a bigger fall in investment in the 90s than we've had this time.

The fact that the opposite is the case is, therefore, troubling - especially as profits are reasonably high now, firms have been retaining cash and banks' lending criteria seem to have loosened a little.

All this is consistent with (though not proof of) a grim prognosis - that firms simply lack investment opportunities.

This in turn augurs very badly for growth. With the government cutting spending next year, and households likely to suffer a squeeze on disposable incomes, other sources of aggregate demand will be weak. So if investment doesn't grow, it's not obvious that the economy will.

* There was a spike in reported spending in 2005Q2, but this was because of a quirk in the statistical treatment of investment by British Nuclear Fuels Ltd.

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