Private Business Net Investment Remains in a Deep Ditch

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If any one
thing estimated in the Commerce Department’s National Income
and Product Accounts may be described as the engine of economic
growth, private domestic business net investment is that
thing. This variable has such tremendous importance because, if
accurately gauged, it tells us better than any other measure how
many resources are being devoted to building up the private business
capital stock and improving it by innovation. An economy that has
anemic private business net investment almost certainly will falter
soon, if it is not doing so already.

Notice that
every aspect of this awkwardly named variable is critical.

  • First,
    it has to do with private investment, not so-called government
    investment. The latter, which looms fairly large in the official
    accounts, ought never to have been labeled as investment, because
    it comes about not as a result of wealth-seeking motives and rational
    economic calculation, but as a result of political motives, calculations,
    and actions that often clash with the creation of real wealth,
    rather than contributing to it.
  • Second,
    we are looking here at business investment, excluding what
    the Bureau of Economic Analysis calls private “household
    and institutions” investment, which has somewhat murky underlying
    objectives, determinants, and consequences.
  • Third, we
    are examining net, rather than gross, investment. The latter includes
    a large element of expenditure aimed merely at compensating for
    the wear and tear and obsolescence of the existing stock of private
    business capital. For example, even at the most recent peak for
    gross private domestic business investment, in the third quarter
    of 2007, it was running at $1,661 billion (annual rate), whereas
    net private domestic business investment was only $463 billion
    (annual rate), or about 28 percent of the total. (The investment
    data cited in this article are taken from Table 5.1, Saving
    and Investment by Sector
    , in the National Income and Product
    Accounts, accessed 02/16/11.)

It is obviously
important that businesses compensate for ongoing depreciation of
their existing stock of capital goods, which includes structures,
tools and equipment, software, and inventories. But unless firms
do more than make up for depreciation, they do not expand their
productive capacity except to the extent that they can embed improved
technology in their replacements for worn-out or obsolete capital
goods. In general, economic growth requires net investment, and
more rapid economic growth requires a greater rate of net investment.

With that essential
idea in mind, let us examine what has happened recently to private
domestic business net investment, which I will henceforth call simply
net private investment. Such investment reached its recent cyclical
peak in the third quarter of 2007, at $463 billion (annual rate).
It then fell steadily for the next four quarters, reaching $336
billion in the third quarter of 2008. At that point, it plunged
steeply, falling to only $159 billion, or by 53 percent, in the
fourth quarter of 2008.

Although the
financial-market panic that had flared up in late September 2008
began to subside early in 2009, net private investment continued
to fall, becoming negative (–$53 billion, annual rate) in the first
quarter of 2009 and even more negative in the second quarter (–$119
billion). Although some improvement began in the third quarter of
2009, net private investment remained negative during the third
and fourth quarters. For the entire year 2009, the amount of net
private investment amounted to a large negative amount (–$69 billion).
So, in other words, the value of the private business capital stock
fell by that amount. Hardly by coincidence, real
GDP also fell
substantially in 2009, by 2.6 percent.

In 2010, net
private investment increased smartly for three quarters, reaching
an annual rate of $270 billion in the third quarter, then contracted
sharply – by almost 47 percent – to $144 billion in the
fourth quarter. For the entire year, the amount of private net investment
was $177 billion. Whether the collapse in the final quarter of 2010
will turn out to have been a fluke or the beginning of a longer-term
decline, we shall have to wait to see.

According to
the National Bureau of
Economic Research
, the most recent business-cycle peak occurred
in December 2007, and the trough was reached in June 2009. As we
have seen, net private investment peaked slightly sooner, in the
third quarter of 2007. So, we are now more than three years past
the economy’s overall peak and some 20 months past its trough,
yet net private investment in the most recent quarter was running
at only 31 percent of the annual rate at its previous peak.

Private net
investment is currently running far below the rate required to sustain
a rapid rate of economic growth. Real consumer spending, in contrast,
peaked in the fourth quarter of 2007, fell only slightly (about
2.5 percent) to the second quarter of 2009, and by the fourth quarter
of 2010 exceeded its previous quarterly peak (by almost 1 percent).
Despite the wailing and gnashing of teeth among Keynesian economists
and politicians with regard to allegedly inadequate consumption,
a collapse of consumption is not to blame for the economy’s
anemic recovery to date. However, looking elsewhere for the cause,
we find that the economy’s true engine of growth – private
business net investment – continues to sputter, running in
the most recent quarter at less than a third of its previous peak
rate and, for the entire year 2010, at only 40 percent of its rate
for the entire year 2007.

Unless net
private investment recovers more rapidly, the overall economy’s
recovery is sure to remain slow, at best, certainly too slow to
bring down significantly the high unemployment rate that has been
stuck for a long time between 9 percent and 10 percent (and would
be substantially greater if we took into account the millions who
have left the labor force recently because they did not believe
they could find a job even if they searched for one). As matters
now stand, real stagnation is a likely prospect and, given the Fed’s
massive ongoing purchases of Treasury debt and the stupendous amount
of excess reserves in the commercial banks’ accounts at the
Fed, stagflation also seems to be a credible expectation.

Investors continue
to view the future with major misgivings, owing to the unsettled
condition of the government’s future actions with regard to
health care, financial regulations, energy regulations, taxation,
and other matters that have serious implications for business costs
and the security of private property rights in business capital
and its returns. Although ObamaCare and the Dodd-Frank bill have
already been enacted, these massive statutes leave scores of important
details awaiting determination by administrative agencies and courts
whose actions will be fiercely contested at every step. Future tax
rates also remain up for grabs in Congress.

Nor are the
investment-paralyzing uncertainties confined to the United States.
Europe in particular continues to wrestle with the aftermath of
the malinvestments and other distortions wrought in its asset markets
and financial institutions during the boom of 2002–2006, and several
countries teeter on the brink of sovereign default. Given the close
linkages of national markets in today’s world, U.S. companies
will feel a great impact from any new crises in Europe – something
else to worry about as they contemplate the desirability of increasing
their investment spending.

Of course,
the major trading countries and their governments may ultimately
find a way to muddle through. They have eventually weathered major
storms in the past. Yet, however the world’s economy moves
in the longer term, the immediate prospect for investors in the
U.S. economy remains troubled, at best. A substantial, rapid recovery
of private business net investment must await the clearing of these
clouds. Until such a recovery does occur, however, overall economic
prospects must remain rather gloomy for the near and medium terms.

from the Independent

21, 2010

Higgs [send him mail] is
senior fellow in political economy at the Independent
and editor of The
Independent Review
. He
is also a columnist for His
most recent book is Neither
Liberty Nor Safety: Fear, Ideology, and the Growth of Government
He is also the author of Depression,
War, and Cold War: Studies in Political Economy
, Resurgence
of the Warfare State: The Crisis Since 9/11
and Against
Leviathan: Government Power and a Free Society

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