Lagging Investment: The Cost of the Upside-Down Economy

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The current economic recovery has been unique in many respects. It was the first "job loss" recovery since World War II. For most of the first two years of the recovery, total employment was below the levels at the start of the recovery. Total compensation growth was the lowest in any post-war recovery. After eight quarters of recovery, total compensation was less than 3 percent higher than at either the start of the recovery or the recession. Simultaneously, after-tax profit rates rose to record highs, marking this as an 'upside-down' economy, whereby corporate gains soared and labor's gains reached new lows.

Another distinct and not unrelated facet of this recovery was the prolonged decline in business investment that lasted longer than any prior decline well into the second year of the recovery.

Only in recent quarters has investment begun to grow again. Yet, it will take years before investment reaches again the economic importance of the late 1990s. And much of the recent investment growth has benefited only a few industries. For example, industrial capacity in the manufacturing sector outside some information-technology (IT) sectors has not changed compared to the start of the recession.

The decline in investment was not due to a lack of corporate profits. On the contrary, companies were more profitable than ever before. Instead, firms saw no real reason to invest more due to large overcapacities.

Consequently, firms put their resources to other uses. Dividend pay-outs and share repurchases remained popular uses of corporate funds after 2000. Thus, firms prioritized speculative investments over productive ones because demand growth was low. In other words, faster demand growth would provide companies an incentive to prioritize productive investments over speculative ones, thereby stabilizing the recovery. Because investment is the only economic sector that still has room to grow, unlike consumption or government spending, its increase will be critical to making the recovery sustainable. More capital expenditures will also boost the country’s capital base and thus lay the foundation for future productivity growth.

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Dr. Christian Weller is a senior economist at the Center for American Progress.