Investment Is Lagging
In our recent paper Why Is Capital Investment Consistently Weak in the U.S. Economy?, my co-author Tom Duesterberg, executive director of the Manufacturing and Society in the 21st Century program at the Aspen Institute, and I review the trend in investment since 2000. It is clear investment has lagged the growth of the economy, cash flows, profits, and other financial metrics. When you look at investment net of depreciation, the story is even worse. Lagging investment helps explain why the recovery from the Great Recession is typically described as “modest,” “weak,” and “tepid.” There is a growing consensus among economists that the modest growth rate observed in recent years reflects a new normal in which growth, going forward, will not match the economy’s post-war performance.
Investment contributes to GDP growth directly and also indirectly through its impact on productivity. As the amount of capital per worker increases, labor productivity tends to rise. In addition, investment contributes to technological improvements and innovation, which are picked up in a residual measure called total or multi-factor productivity. Productivity growth since 2005 has slowed because investment has lagged.
Demographic factors are partly to blame for slower economic growth. With an aging population, we are seeing the retirement of baby boomers who possess skills and experience. The growth of educational attainments also has leveled off. These factors are largely beyond policy influence.
Investment, however, can be influenced by policy. But first we ask: Why is investment spending lagging? One factor might be a reduction in what Keynes called “animal spirits”—that urge to invest that doesn’t rely on textbook financial metrics, although these metrics obviously have an important role. There also is evidence that uncertainty created by economic and government policy (corporate taxes, environmental regulation, and financial regulation such as Dodd-Frank) has increased. Uncertainty leads companies to hold off or reduce investments, especially fixed investments that, once made, are sunk.
Some believe there has been a decline in entrepreneurialism, say as measured by the number of new start-up business or trends in venture capital spending. For example, new business creation peaked in 2006. In 2012, the number of new businesses was 27% below its 2006 peak.
Another factor is said to be the lack of breakthrough technologies that attract investment in the way that electricity, automobiles, and television did. This is a variation of the secular stagnation argument first made in the late 1930s by Alvin Hansen, now echoed by Robert Gordon and Tyler Cowen. Secular stagnation cannot be dismissed out of hand, but we have a more optimistic outlook.
Finally, U.S. corporate tax policy, the growing burden of an ever-increasing number of regulations, and the absence of global trade agreements create headwinds for investment. As we argue in our paper, these factors can and should be addressed by policy changes. For example, U.S. companies face higher corporate tax rates than most companies located abroad. Reducing the corporate tax rate and allowing the expensing of investment would help spur investment. Easing the burden of an ever-increasing number of regulations that impose costs on companies and add to uncertainty also would encourage more investment. This can be done by reviewing and then changing or even eliminating poorly conceived, anachronistic, or overly burdensome regulations. With respect to international trade, we should aggressively promote trade-opening agreements and the enforcement of existing agreements.
Investment is a key driver of productivity growth. To the extent we can encourage more investment we should expect to see improved productivity growth and eventually a higher rate of economic growth than we otherwise will have if investment continues to lag.