Investment the key to growth

Elliot Clarke at Westpac recently highlighted the importance of investment in sustaining economic growth:

The importance of sustained investment in an economy cannot be understated. Done well, investment in real capacity begets greater production volume and employment as well as a productivity dividend. Its absence in recent years is a key factor behind sustained soft wage inflation and the US economy’s inability to consistently grow at an above-trend pace despite the economy being at full-employment and household balance sheets having more than fully recovered post GFC.

The graph below highlights declining US investment in new equipment post GFC.

S&P 500

source: Westpac

There are three factors that may influence this:

  1. Accelerated tax depreciation allowances after the GFC encouraged companies to bring forward capital spending in order to stimulate the recovery. But the 2010 to 2012 surge is followed by a later trough when the intended capital expenditure was originally planned to have taken place.
  2. Low growth in personal consumption, especially of non-durable goods and of services, would discourage further capital investment.

US Net Debt & Equity Issuance

  1. The level of stock buybacks increased as companies sought alternative measures to sustain earnings (per share) growth. The graph below shows debt issuance has soared while net equity issuance remains consistently negative.

US Net Debt & Equity Issuance

source: Westpac

Net capital formation (the increase in physical assets owned by nonfinancial corporations) declined between 2015 and 2017. While this is partly attributable to the falling oil price curtailing investment in the Energy sector, continuation of the decline would spell long-term trouble for the economy.

US Net Capital Formation

The cycle becomes self-reinforcing. Low growth in personal consumption leads to low levels of capital investment ….which in turn leads to low employment growth…..leading to further low growth in personal consumption.

Major infrastructure investment is needed to break the cycle. In effect you need to “prime the pump” in order to create a new virtuous cycle, with higher investment leading to higher growth.

It is obviously important that infrastructure investment target productive assets, that generate income, else taxpayers are left with increased debt and no income to service it. Or assets that can be sold to repay the debt. But the importance of infrastructure investment should be evident to both sides of politics and any attempt to obstruct or delay this would be putting political ahead of national interests.

Australia

Australia is in a worse position, with a dramatic fall in investment following the mining boom.

Australia: Business Investment

source: RBA

If we examine the components of business investment, it is not just Engineering that has fallen. Investment in Machinery & Equipment has been declining for the last decade. And now Building Investment is also starting to slow.

Australia: Components of Business Investment

source: RBA

You’ve got to prime the pump…. You’ve got to put something in before you can get anything out.

~ Zig Ziglar

Australia: RBA hands tied

Falling wage rate growth suggests that we are headed for a period of low growth in employment and personal consumption.

Australia Wage Index

The impact is already evident in the Retail sector.

ASX 300 Retail

The RBA would normally intervene to stimulate investment and employment but its hands are tied. Lowering interest rates would aggravate the housing bubble. Household debt is already precariously high in relation to disposable income.

Australia: Household Debt to Disposable Income

Like Mister Micawber in David Copperfield, we are waiting in the hope that something turns up to rescue us from our predicament. It’s not a good situation to be in. If something bad turns up and the RBA is low on ammunition.

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. The blossom is blighted, the leaf is withered, the god of day goes down upon the dreary scene, and — and in short you are for ever floored….

~ Mr. Micawber in Charles Dickens’ David Copperfield