US businesses hold back on investing

by Michael Collins, Investment Commentator at Fidelity International

August 2016

In the US in recent years, internet-based companies have invested countless billions of dollars to make the US the world leader in mobile broadband and other savvy technologies. Oil and gas explorers have invested so much they have boosted US oil output by four million barrels a day and made the US one of the world’s leading exporters of liquid natural gas. Clean-energy companies have invested so many billions they have tripled wind-energy generation and multiplied solar generation twentyfold since 2008. Even US car makers are investing at home again.

These were investment accomplishments of US companies listed by Jason Furman, President Barack Obama’s chief economist (or, more formerly, the chairman of the Council of Economic Advisers) before he sought to highlight one of the puzzles of the US recovery.[1]

The US economy has expanded since 2009 thanks to buoyant consumer demand, government stimulus at crucial times, a recovery in housing and frequent boosts from net exports (exports minus imports). But one ingredient is lacking; namely, growth in business investment or, more specifically, higher business spending on items such as factories, machinery and computers. US business investment has only expanded 2% a year over the past decade, the lowest rate since World War II. The question Furman and others have posed is this: Why are companies not investing more when earnings are at all-time highs and interest rates are at record lows?

The US investment shortfall is best expressed in the amount of dollars not invested based on past trends. On this measure, the US is faring worse than advanced economies overall. The IMF estimates that private investment in the advanced world has declined by about 20% since the crisis began in 2007 compared with pre-crisis forecasts, a result that compares unfavourably with an average decline of only 10% after previous recessions. The drop for the US, however, is about 25%.[2] That’s an estimated missing US$400 billion of investment in the US.[3]

Most of the drop is in spending on equipment. Money ploughed into producing intellectual property has swelled, especially into the research and development component. That brings us to the first explanation for the missing billions of US investment; that investment is tied to innovation and is thus centred in industries enjoying technological advances. In recent years, investment in IT and energy has hummed thanks to computing-based advancements and the hydraulic fracking that drives the shale revolution. In contrast, in other industries such as materials and healthcare, there is a relative lack of profitable innovation-related investment opportunities.

Another theory to explain morbid investment is that the internet has given birth to capital-light companies that can have a greater market capitalisation than traditional companies that produce goods in factories. The weakness with the explanation is that, firstly, other companies have invested to build the networks that internet-based companies and their users enjoy. The second is that the rise of the internet did nothing to deter investment before the global financial crisis.

The most probable cause for sluggish business investment, however, is weak economic activity; that the US’ sluggish growth is creating a downward spiral. Why are businesses so hesitant when the economy has expanded for more than seven years? A weak global economy, US political uncertainty, a high US dollar and, above all, the battering from the global financial crisis have made businesses risk averse.

What then can policymakers do to boost investment? The simplistic answer is anything that rallies business morale will boost investment. Obviously less red tape, tax breaks and easy access to credit would help. So too would freer international trade. The best solution, though, might be government spending that alters the equation for businesses by spurring demand.

Financial information comes from Bloomberg unless stated otherwise.