Thursday, June 25, 2009

The Worrying I in C + I + G + NX

The final figures for Q1 GDP were released this morning and although nothing drastically changed (revised up to -5.5% from -5.7%), the figures for non-residential investment are still important to review.

Investment is important to long-term economic growth and/or recovery. One such study by Brad De Long and Larry Summers on the relationship between equipment investment and economic growth noted:

We find that producers’ machinery and equipment has a very strong association with growth: in our cross section of nations each percent of GDP invested in equipment raises GDP growth rate by 1/3 of a percentage point per year. This is a much stronger association than can be found between any of the other components.
For that reason, a massive drop in investment is not only cause for concern now, but for future and lasting economic growth. And the size of the drop in investment is massive.

Source: BEA


  1. Could argue that the cost of investments are lower now. Same amount of stuff, but spending less.

    BTW, anyone know if there is an international comparison of investment as a % of economy?

  2. that is (or at least should be) accounted for in the price deflator. these are real (not nominal) figures

  3. Summers and DeLong figured this out?

    Try Hayek in the early 30's. Prices and Production.

    Structures and Machinery are the early stages of production. If there are productivity advancements (ie. profits) to be made from consumer goods, then demand will originate in the early parts of the structure of production, where interest rates are low and profit margins are therefore much higher.

    However, if government spending binges cause angst that either a) borrowing rates for producers will soon rise or b) the future implied tax rate is rising, then the current benefit of lower interest rates and perceived future profits will be offset by such interventions and entrepreneurs will instead choose to do nothing.

    Precisely what is happening now.

    I find it hilarious that these pseudo neoclassical economists keep rediscovering basic parts of the Austrian Theory of the Business Cycle and pass it off as their own "findings."

  4. Thanks for the comment, but I never said "figured it out"... I simply said "one such study".

    Not sure i understand point A... if borrowing rates are expected to rise, then why not take out a fixed rate loan NOW when borrowing costs are low in nominal terms (especially if you think inflation will rise, which will reduce the cost of the loan and increase the value in real terms of the equipment).

  5. Bravo - keep hammering on this. Too many a couple of years ago argued that as consumption waned investment would pick up. Despite the Austrians (need we mention Drucker who worshiped at the dinner table with them)Investment is made by businesses anticipating growing demand. When you have weak growth you get lower investment and hiring. And it lags the business cycle, naturally. This will be a long and drawn-out weak recovery IMHO which means investment won't "recover" for years. Any talking who head who starts babbling should be exiled to CNBC and ousted from the real world. Oh wait, my bad. That's where they are.

  6. Jake,

    Not pointing fingers at you my man. You do great work. I got peeved by the "we find" part of Summers and DeLong.

    In regards to A mentioned above. The motive to invest in the early stages of production is dependent on future demand from the later stages of production.

    In a free economy, there should be no reason for implied borrowing costs to rise unless there is ample demand for loans, which implies a recovery.

    So we need to distinguish why rates would rise. Is it because of rising demand in the later stages of production? Perhaps, inventories got smacked Q4/Q1. But rising inflation fears should not entice entrepreneurs to make long term investments - it does nothing to increase profitability.

    Honestly, I'm still learning these things right now. So my ability to explain it is pretty weak. But what I do know is that a true recovery based on savings->productive capacity->production->consumption can not be driven by inflation. Only malinvestment and overcapacity can come from that. And rising/falling cost of obtaining loans has a far different effect on the different stages of production as it skews people's time preferences (toward consumption goods and away from productive goods).

    More can be learned from Böhm-Bawerk's interest rate theories.

  7. thanks for the additional insight matt