Business Investment Too Narrow
At the risk of repeating ourselves, it is worth bearing in mind that this recovery has been different from other recoveries. While much of the attention paid to the economy has focused on the sluggish jobs picture, less attention has been paid to investment. One of the factors that tend to drive the economy out of recessions is businesses investment. Not so this time. In recovering from the 2001 recession, it was only when the recovery was well into its second year that investment began to pick up again. The latest glimpse of what is happening with investment was provided yesterday by the Federal Reserve's Beige Book – its regular review of regional economic conditions. The report and related data suggest that investment growth may be too narrow – the growth may be limited to a few items, it is showing some regional weaknesses, and the increases could be the result of investment tax incentives that are expiring at the end of this year.
A number of data series have shown that the increase in investment spending since the second quarter of 2003 has been concentrated in just a few areas. For instance, investment in commercial and industrial structures continued to decline through the first quarter of 2004. Yesterday's Beige Book indicates that this has not yet changed as "[n]onresidential [real estate] activity was still relatively weak across the nation." Statistics from the Federal Reserve on industrial production also suggest that investments in equipment were largely concentrated in information technologies (IT). Industrial production of computers, communications equipment, and semiconductors rose by 16.1 percent from December 2003 to August 2004. However, industrial production outside of these IT-related products has risen by just 0.3 percent. It appears that the investment engine is not running on all cylinders.
It is worrisome that much of the investment growth is a result of a spurt in IT spending, since there are several reasons why this kind of growth may not be sustainable. IT-related products tend to have a shorter life span than other investment goods, and computers and software are typically upgraded within a few years. So, it would not be that surprising to see businesses starting to invest again in IT-related products in the middle of 2003, since they have been reducing new investments in this area for nearly the past two years. The real question is whether the data show a recovery of investment or just a temporary surge due to businesses replacing obsolete equipment. If the latter is true, investment increases may slow again in the near future.
Another weakness in current business investment is that a number of indicators show investment growth not yet finding a consistent growth pattern. For instance, the Federal Reserve reported in yesterday's Beige Book that "capital spending appeared to pick up modestly." It seems that increases were especially noted in the areas around Philadelphia, Chicago, and St. Louis. The regions around Cleveland and St. Louis, though, seemed to show a more mixed picture, with investment spending varying from industry to industry. This is also reflected in month-to-month volatility in durable goods orders. The U.S. Census Bureau reports that durable goods orders, which many economists take as an indicator of the direction of investment, declined in four out of eight months.
Worrisome also is the fact that some of the recent increases in investment may be due to investment tax incentives that are expiring by the end of this year. The Federal Reserve writes in its Beige Book that the Federal Reserve Bank of Chicago "…added that special factors, such as expiring tax incentives…, contributed to higher capital outlays." If this is true for the broader sector, business investment spending should slow down by early next year.
As the economy nears the end of its third year in this recovery, many wonder about what lies ahead. The future of economic growth will hinge to a large degree on whether businesses continue building up their capacities by increasing their investing. So far, investment has grown, but the pattern of investment across industries, across regions and over time has been too uneven to suggest another sustainable investment boom.
John S. Irons is the associate director for tax and budget policy at the Center for American Progress. Christian E. Weller is senior economist at the Center for American Progress.
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Christian E. Weller