J Brauer | © Stone Garden Economics
Endless is the talk about how to stimulate the U.S. economy. Economists arrive at one important measure of the economy, GDP, by various routes. One of them entails adding up the dollar value of certain categories of expenditure streams in an economy. Thus, spending by the private, government, and foreign sectors on goods and services requires their production (hence gross domestic product) and generates a corresponding income stream. The foreign sector refers to the value of exports (which brings money into the country) minus the value of imports (which leads to dollars being spent in other, non-U.S., economies). The government sector refers to federal, state, and local government spending. It thus excludes, for example, social security or pension payments which, even though they happen to be administered via a federal government agency, are just transfers from one private to another private person and therefore private sector spending.
Private sector spending also includes gross private domestic investment (GPDI) by business firms. Often abbreviated simply as “I,” the term implies that there should be a “net” private domestic investment, as indeed there is. The difference between gross and net is depreciation, or “capital consumption” as economists also call it.
Suppose a firm has an installed capital base of plant, property, and equipment worth US$100 million and that during the year, ordinary wear and tear of capital used in production is deemed to amount to US$70 million. In the following year, the firm would have only US$30 million worth of capital to work with. Just to keep standing still, the firm thus needs to invest US$70 million to make up for the prior year’s consumption of capital. If, in addition, it wanted to invest an extra US$20 million, that extra bit would be net investment. Gross investment is the sum of replacement investment for worn-out capital, plus expansion investment.
Net investment, however, can be negative! In our example, suppose the firm replaces the US$70 million worn-out capital with only US$60 million. The missing US$10 million is negative net investment as the overall capital stock of the firm shrinks ($100 million – $70 million + $ 60 million = $90 million).
In any economy, positive net investment is of crucial importance. The more capital per worker, the more productive the worker can be. Productive workers earn their bosses profits, of course, but they also earn themselves an ever higher standard of living. Mere replacement investment keeps workers as productive as before, but no more. Negative net investment undermines workers’ ability to be productive. Only positive net investment does the trick.
Figure 1 shows U.S. gross and net private domestic investment, and capital consumption, from 1929 to 2010. For comparability across the years, the numbers are adjusted both for inflation and for population growth.
Sensitive to the business and political climate, net investment shows high volatility. (Why invest if you don’t believe that your investment will bring an appropriate return on investment?) Thus, periods of high inflation and of correspondingly high interest rates (e.g., the late 1970s), political uncertainty (e.g., the famous Supreme Court decision in December 2000 on whether Mr. Bush, Jr. or Mr. Gore would assume the U.S. presidency in January 2001), but also virtually all war periods (World War II, Korea, Vietnam, Reagan Cold War, and 9/11 and the Afghan war) have led to downturns in net investment.
Yet the 2009 economic crisis was of an altogether different magnitude and, for net investment, led to an even greater than that which occurred during the Great Depression. Granted, some of the net investment collapse in 2009 is accounted for by the collapsing housing market (private residential housing is treated as part of investment, rather than consumption). Nonetheless, net investment of households and institutions (other than government) remained positive in 2009, to the tune of some US$127 billion. In contrast, business net investment turned negative by US$122 billion. Consequently, the overall result was effectively zero per capita net investment. By 2011, business still had not recovered even to its 2008 level.
As I explained in a December 2010 column, in the U.S., economic booms and recessions are driven by business enthusiasm or lack thereof. What Congress needs to do is to reassure the business sector. But with the Afghan and Iraq adventures winding down only now—and with potential new military adventures on the horizon—there is no room in the federal budget, nor much appetite to place the U.S. taxpayer even further in debt, to stimulate business. Fortunately, business is well versed to take care of itself. What it needs is not tax breaks or government largesse. What it needs is, preferably few, but in any case clear, reliable, and impartially enforced rules of the game, along with congressional and presidential credible commitments to get their political and financial affairs in order. Unfortunately, that is unlikely to happen anytime soon.
J Brauer is Professor of Economics, James M. Hull College of Business, Augusta State University, Augusta, Georgia, USA.