Business investment in the UK has fallen since 2016. Everybody blames this on Brexit uncertainty. Figures next week, however, should remind us that this is only part of the story.
On Wednesday, official US numbers are likely to confirm that non-residential investment has fallen in the last two quarters, despite the fact that borrowing costs are near a record low. This can’t be blamed on Brexit.
Yes, it is due in part to troubles in some big companies such as Boeing and General Motors – although this should remind us of an important point made by Harvard University’s Xavier Gabaix, that macroeconomic downturns can begin from problems at individual large companies.
There are, however, more general reasons for such weakness.
One is political uncertainty – especially about the trade war. As Stanford University’s Nick Bloom has shown, this can have a powerful effect in depressing investment, as companies wait for the fog to lift before approving new projects.
A second is that many companies still have spare capacity. Official figures show that the utilisation rate in industry is lower than it was in 2014, and well below the levels seen in much of the 1990s and mid-2000s. Many companies, therefore, don’t need to expand.
Thirdly, there might well be a scarring effect. The tech crash and financial crisis have taught companies that there’s a big risk that ambitious plans will not pay off. As a result, animal spirits are lower now. Stanford University’s Charles Lee and Yale’s William Nordhaus have shown that the payoffs to past innovation and capital spending have been low. Bosses should by now have wised up to this fact.
Fourthly, and perhaps most worryingly, profit rates are falling. This naturally deters investment.
All this is worrying. Falling capital spending is a reason to worry about future growth. For one thing, it’s a cause of weakness: low investment means low productivity and hence low potential growth. And, for another, it is diagnostic of it. It is a sign that companies are pessimistic about future prospects. The fact that there is often wisdom in crowds – at least when money is at stake – warns us to take such pessimism seriously.
This is not to say, however, that there’s a worldwide problem here. The eurozone is bucking the trend of the UK and US. There, investment has grown strongly in recent months, perhaps because there is less of a legacy of past over-investment, or perhaps because low borrowing costs are having the desired stimulative effect.
Nevertheless, such weakness in the US and the UK poses a question for equity investors: if business leaders – who should know the ground truth about economic prospects – are reluctant to invest, why should we be keen to do so?
