Investment, growth & animal spirits
Duncan says we should be concerned by today’s news of a collapse in capital spending because “investment is the driver of long term growth.”This sounds sensible. But it raises a problem, shown by my chart. It plots the share of business investment in GDP, measured in current prices, against annualized GDP growth over the following five years.
There’s a negative relationship between the two. High investment leads to slow growth, and low investment to high growth. This relationship suggests that today’s figures - showing the investment-GDP ratio at its lowest since records began in the mid-60s - are a reason for optimism about economic growth, not pessimism.There might be a simple reason for this. Businesses’ investment decisions are not rational. High capital spending, then, is not a sign that there are lots of growth opportunities in the economy, but that bosses are irrationally overconfident and have been swept away by the euphoria of an economic boom. And booms lead to busts. Similarly, low spending is an indicator not that growth opportunities are scarce but simply that animal spirits are irrationally depressed.If this is right, today’s low investment tells us not that the economy is heading for hard times, but simply that bosses are irrational.There are, however, (at least) two counter-arguments here.1. This time is different. Current low investment isn’t due to irrational pessimism, but to firms being starved of finance by banks. 2. In looking at actual GDP growth, I’m using the wrong metric. Maybe capital spending does influence trend GDP growth, the rate at which the economy can grow without generating inflation.I’m not sure, though, if any of this actually rejects Duncan’s main point. After all, if investment is so swayed by irrational animal spirits then there might - subject to other postulates - be a case for taking it out of capitalists’ hands, as Keynes said.