The investment problem

The UK is recovering. Surveys by Markit and the BCC show that output and orders are rising. There is, though, (at least) one big black cloud here, shown in my chart.It's that firms are still loath to invest. In fact, in Q1 non-financial companies capital spending fell to just 57.9% of retained profits - the lowest rate since records began*. I'm not sure things have much changed since March. The BCC's otherwise up-beat survey found that services companies' capex is still low, and Bank of England data show that firms are still increasing cash piles and repaying debt - consistent with a continued aversion to real spending. 

It's hard to blame this investment dearth upon firms being forced to save by credit constraints. Today's Bank of England survey shows that the availablity of credit to firms has generally increased since 2010. And April's CBI survey (pdf) found only 12% of manufacturers saying that a lack of finance is a constraint upon investment.

So, what is the problem? There's a cyclical problem of weak demand; that CBI survey found 54% of firms saying investment was constrained by uncertainty about demand and 40% saying it was constrained by inadequate prospective profits. I'd add that this is overlain upon a longer-term lack of monetizable investment opportunities: note that the fall in the ratio in my chart came in the early 00s, and not during the crisis.

You might, however, suggest another, rosier possibility - that the relative price of capital goods has been falling, so that a given amount of nominal spending now goes further than it did: the prices of business investment goods haven't change much since the early 00s, which means they have fallen considerably relative to the GDP deflator.

This possibility, though, runs into two problems:

- Why isn't the  price-elasticity of demand for capital higher? If it were greater than unity, then, we'd have seen nominal investment rising rather than falling.

- It deepens the productivity puzzle. It's sometimes said that labour productivity has stagnated because firms have substituted from capital to labour. However, since 2010 capital goods (measured by the business investment deflator) have fallen by around five per cent, pretty much the same as real wages. Now, it's perfectly possible for there to be capital-labour substitution without a change in relative prices. But to the extent that there has been, it's hard to attribute this merely to the drop in real wages.

Whatever the reason for weak investment, two things are clear. One is that we'll not get a decent recovery unless this changes. The other is that the long-term weakness in capital spending seems inconsistent with neoliberal notions that low business taxes and a quiescent labour force will increase investment.

And herein lies my worry. Low taxes and weak workers might not be sufficient to promote investment. But it is theoretically possible that they are necessary. If so, then the social democratic response to neoliberalism might be inadequate.

* The new vintage of data only goes back as far as 1998; the ONS is even better at expunging figures from history than Stalin was. However, previous vintages of data show that capital spending was a far higher share of retained profits in the 1980s and 90s - quite often exceeding 100%.

Comments

[Blissex]

"And herein lies my worry. Low taxes and weak workers might not be sufficient to promote investment."

But there massive investment: in highly profitable activities like speculating on property and fencing in the capital markets.

Both house speculation and fencing in the capital markets have much higher rates of return than banausic industrial activities in manufacturing or services, and both are generously government funded with vast showers of free credit and free insurance against losses.

Not only property and financial speculation has been a massive engine of upwards redistribution, it has also displaced other forms of investment.

Only losers have been investing in valuea-added producing activities in the UK in he past couple dozen years, because returns are much lower and risks much higher than in government funded and insured activities like speculation that produces economic rent.

[Metatone]

Blissex points to something there should be some discoverable info about. What happens to corporate cash piles?

We know they are too big to be in £50 notes under the CEO's mattress. So are they being invested in some manner through banking/shadow banking? What's the typical rate of return?

(I'm assuming that actually finding out what they are invested in isn't easy.)

[chris]

@ Metatone. Table X15 of the UK National Accounts show that firms got £3.8bn in interest income in 2012. That's a rate of less than 1% on their total cash holdings (table A57). Here's a big pdf:
http://www.ons.gov.uk/ons/rel/naa1-rd/united-kingdom-economic-accounts/q1-2013/bod-ukea-2013q1.pdf

[Blissex]

From A8 in national aggregates I find this nice table of gross capital formation, 15 years 1997 to 2012:

DLWZ Transport equipment
DLXI Other machinery & equipment
DFDK Dwellings (3)
EQEC Other buildings & structures (4)
DLXP Intangible fixed assets
NPQX Total

DLWZ DLXI DFDK EQEC DLXP NPQX
11,745 44,137 28,467 39,070 19,015 142,433
13,521 47,737 32,747 45,079 20,856 159,940
10,263 48,275 32,191 51,437 23,790 165,956
9,634 49,432 34,535 54,148 23,752 171,501
10,690 39,880 35,578 62,036 28,419 176,602
15,662 41,179 36,914 62,586 28,784 185,126
14,308 43,532 44,620 56,404 32,747 191,611
13,045 41,405 49,982 66,469 34,126 205,027
11,482 39,805 50,450 80,571 32,062 214,371
11,902 37,317 62,614 90,631 29,396 231,861
11,011 42,742 62,645 106,077 31,513 253,988
11,378 44,424 55,788 100,820 33,137 245,549
10,512 37,059 42,712 90,992 29,918 211,195
14,213 39,952 50,450 83,860 32,680 221,156
4,633 40,238 52,977 88,521 34,359 220,726
6,043 44,595 51,135 86,058 36,421 224,252

I don't know exactly what DFDK and EQEC are made of, but I uepect it does not include purely financial speculation. Still the numbers are impressive. (including the vertical collapse of "transport equipment" in recent years.

[Metatone]

@chris - isn't that bizarre though?

1% is a pretty low threshold to beat for an investment opportunity. You might think shareholders would complain.

Perhaps there is something driving a need to hold cash, rather than holding cash being a side-effect of failing to invest?

[Luis Enrique]

I'm always wittering on about the possibility that nowadays spending money to expand productive capacity needn't look like investment, I guess this would be a partial test: "we'll not get a decent recovery unless this changes". If I'm right, would could get a decent recovery without a particularly large investment increase.

I suppose we could get an investment increase without a real GDP recovery too. Suppose exchange rates move sharply and imports from China etc. are now much more costly. We could see investment rise as it then makes more sense to manufacture things in the UK. However real wages would still fall because UK manufactures are still relatively more costly than today's imports.

[Metatone]

@Luis Enrique

I seem we had a small discussion in comments once about "extra people" as a means to expand production (through developing new services etc.)

Are there other mechanisms that come to mind?

[FromArseToElbow]

Part of the answer to Metatone's question is that companies may use free capital to fund share buybacks. This can be a more tax-efficient way of returning cash to shareholders than special dividends.

[aragon]

Yes, the social democratic response is inadequate, and only addresses part of the problem.

Here briefly is the Henry Ford Argument:
https://www.nytimes.com/2012/09/03/opinion/henry-ford-when-capitalists-cared.html

"But he was one of the first business leaders to articulate what economists call “the virtuous circle of growth”: well-paid workers generating consumer demand that in turn promotes business expansion and hiring."

And the rebuttal (not that the rebuttal addresses the aggregate demand issue, and Boeing (is a straw man) sells to airlines, who sell seats on aircraft to people!).

http://www.forbes.com/sites/timworstall/2012/03/04/the-story-of-henry-fords-5-a-day-wages-its-not-what-you-think/

"In short, German leaders have practiced stakeholder capitalism and followed the century-old wisdom of Henry Ford, while American business and political leaders have dismantled the dynamics of the “virtuous circle” in pursuit of downsizing, offshoring and short-term profit and big dividends for their investors."

[David Ellis]

When you become a monopoly further investment can only endanger that monopoly and of course there is no point of entry for new capital the rates of return being only of use to the most gigantic capital. The means of production are now so vast, the constant capital tied up in them so enormous, that only monopolists assisted by their state can make a profit and of course monopoly profits are maintained by selling products above their true value which eventually sucks all the activity out of the system. Profit is killing capitalism. Capitalism can never recover from this. Not even a war sweeping aside the current political economy can give it a new lease of life. There is no America waiting in the wings to pick up the reins as it did after the European civil war of WW2. US-led globalisation was its apotheosis. All that remains now is the rather unedifying spectacle of globalisation being wound off backwards to a new dark ages. Socialism or barbarism baby, socialism or barbarism.

[FromArseToElbow]

Part of the answer to Metatone's original question is that companies may use free cash to fund share buybacks. This can be a more tax-efficient way of distributing money to shareholders than special dividends.

[Metatone]

FATE: so that is driving the accumulation of cash?

(Chicken and egg question perhaps...)

[Andrew]

What's their net position?

Are they holding cash against similarly large debts?

[joannamcclure.com/lovely/]

Stumbling and Mumbling: The investment problem joannamcclure.com/lovely/ http://joannamcclure.com/lovely/