The investment slump
Capital spending has fallen to a record low as a share of GDP. Today’s figures (pdf) show that in Q1 business investment in current prices accounted for 7.9% of GDP - its lowest proportion since records began.OK, in part this is good news - it reflects the fact that the relative price of capital goods has fallen.But this is only part of the story. The volume of capital spending, as a share of GDP, is now close to its lowest since the mid-90s. This matters because capital spending is not only a cause of future GDP growth, but a symptom of it; one reason why firms don’t invest is that they don’t anticipate much future demand growth.But why are firms not investing? Three reasons strike me as only a fraction of the story.“The recession created spare capacity, and this means firms don’t need to invest.” No doubt, this is true for some firms. But if there were general spare capacity, inflation should be lower than it is, at least if you believe conventional output gap stories. “Banks are starving firms of funds.” However, in recent years firms, in aggregate, have not even been investing their retained profits. If firms aren’t even spending internal funds, a lack of access to external ones is not the whole problem.“Osborne’s fiscal squeeze is having conventional Keynesian effects.” Again, partly true, but investment was weak, especially in current prices, even before the recession.I’d suggest two other possibilities.One is that rebalancing is - so far at least - is having asymmetric effects. Companies serving consumers and government know that demand will shift away from them and so are cutting capital spending. But firms in export and investment sectors aren’t yet confident enough to invest. As a result, we’re seeing investment in service sectors fall by more than investment in manufacturing is rising.Secondly, there is still - as Ben Bernanke said back in 2005 - a “death of domestic investment opportunities” in western economies. Quite why this should be so is not clear. Possible explanations include: a slowdown in the rate of technical progress; an inability to profit from what technical progress there is; and the migration of low wage-dependent business to the far east. Two things, though, are clear. First, we know now that demand for investment good is price-inelastic. Lows prices of goods themselves, and low risk-free interest rates, are not enough to get firms spending.Secondly, neither investors nor government nor the general public seem to be prepared for a world of few investment opportunities and weak growth. * That spike in the chart is a statistical blip caused by a change in the way investment in the nuclear industry was measured.