• 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.

    Reprinted
    from the Independent
    Institute
    .

    February
    21, 2010

    Robert
    Higgs [send him mail] is
    senior fellow in political economy at the Independent
    Institute
    and editor of The
    Independent Review
    . He
    is also a columnist for LewRockwell.com. 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
    .

    The
    Best of Robert Higgs

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