‘Over the Hill’: the Secular Decline of the Rate of ‘Fixed’ Investment in Rich Countries and Misdirection in the U.S.

On Voxeu a book about secular stagnation has been published. Can I add something to this? Yes: information on the secular development of the rate of fixed investment (5 graphs).

The book contains a lot of interesting and important ideas about labour (ageing, declining male participation rates), technological possibilities (opinions differ about the magnitude of these possibilities but everybody sees possible improvements in life styles and health) and disequilibrium economics: tenacious interruptions of the flows of money which can not be cured or are even caused by changing relative prices (i.e. lowering then interest rate) are preponderant in the book. And only Smets (from the ECB…), Jimeno and Yiangou still believe in the confidence fairy. But even they advocate a smaller financial sector. ‘Fixed capital’ does however not get enough attention. According to me, progress will be increasingly dependent on household purchases of specialized consumer durables (in combination with cultural changes in life styles) instead of upon government and company ‘fixed investments’ which means that households will have to get the means (i.e. higher incomes) to finance these ‘household investments’. This will not only enable these purchases but it will also be necessary to fill the expenditure gap left by the decrease of government and business fixed investment.

Though sometimes disguised by construction bubbles the rich country rate of ‘fixed’investment (see graph 1-5), i.e. investment in depreciable fixed capital, has shown a downward trend since about the seventies. Policies aimed at compensating this decline in aggregate demand should not, like at the present in the Eurozone, be aimed at curtailing household consumption and government expenditure but to the contrary at boosting household expenditure and/or government consumption, with due regard for the sustainable financing of these expenditures. Which (as the rate of fixed investment has declined) means that the profit share of national income has to decline a little while the labour share and/or the government share have to increase a little. This requires a re-think of the process of investment and consumption. We have moved from a ‘network’ economy with large fixed investments like public sewer systems and private toilets, both financed by ‘fixed investments’, to a network economy where a large part of total ‘investments’ in these networks (i.e. smartphones, computers, adding solar cells to a home) is financed by households. To an extent, ‘Eurosclerosis’ after 1970 (i.e. tenacious high unemployment rates) might have been caused by the inability to fill the hole left by the decline of the investment rate (and, after the Berlin Wall came down, the decline of military expenditure). The investment rate measured as a % of GDP can decline because a decline of investments, which leaves production below potential, or by an increase of government expenditure and household consumption, which leaves the economy at potential. Especially after 2008 but to a lesser extent after 1970 investment decline was preponderant. Tellingly, the European low unemployment economies in the noughties (Netherlands, Switzerland, Norway, after 2010 Germany, though unemployment in the neue Bundesländer is often still in double-digit territory) knew massive surpluses on their current accounts – domestic demand was not large enough to employ the domestic labour force.

The graphs: (note that investment rates which were tenable and sustainable in the sixties were clearly ‘bubbly’ in the noughties!).

Graph 1: the USA. Special about the USA (should be textbook stuff): the very early increase of the investment rate to a 20%+ territory: a sign of things to come. Note the difference between the private rate of investment (the BEA data) and the total investment rate (Eurostat data, spliced to data BEA data on total domestic investment). To compensate a secular decline of the private rate of investment of 4 to 6%, which is totally within the realm of actual events, the government will have to double government investment. This is possible (see the events during World War II) – but is it feasible or even worthwhile? After World War II the rise of the high consumption middle class and the increase of ‘government consumption’ (i.e. services like education, lots of medical services) filled the gap in a more satisfactory way. A new household consumption drive (aimed at solving the problems of ageing and using the possibilities of digital bionics?) seems warranted. Household incomes of the 99% have to increase to enable this.

Graph 2: the exporters. Germany and the Netherlands both know large (Germany) and even excessive surpluses (the Netherlands) on their current accounts. There is no 1:1 relation between a 1% increase surplus on the current account and a 1% increase of unemployment (or a decline of unemployment which is 1% less) as exported goods may be produced in a very capital and ‘land’ intensive way (i.e. natural gas in the Netherlands). The whopping 10% surplus of the Netherlands however indicates a chronic low level of domestic demand, which clearly shows in the relatively large post 1970 decline of the investment rate. Post 2008, Dutch politicians increased real house rents (+16% in four years), pensions savings, VAT (from 19 to 21%) and tried to encourage purchases of existing houses in stead of new products (sales tax on houses went from 6 to 2%). This does not help when you have to combat a secular decline of the investment rate and these are all solid reasons why the Dutch economy is among the worst performing of the entire Eurozone, despite the whopping current account surplus. And oh, the German economy is of course not doing too well, either.

Graph 3: France and the UK. France managed to keep the investment rate at par, at the cost of a somewhat deteriorating current account, however, as countries like Germany and the Netherlands beggared their neighbours by restricting domestic demand. I do think, however, that France has to face the secular decline of the investment rate, too, which means that consumption has to rise. It’s important to note that an increase of consumption never is ‘more of the same’ (not ‘monothetic’, in economese) but ‘more of something else’, which also implies changes in life styles and habits. The UK economy is doing well, at the moment, but has at the same time only regained lost territory. The good thing about the UK is however the increase of purchasing power caused by the increase of ‘total wages’, which enables households to change their consumption patterns into something new, which eventually might make up for the decline of the investment rate (as well as the decline of ‘financial services’). Hey, why was the UK rate so low in the nineteenth century? Update 11:22, Euro area time: just received the Twitter message (via @cigolo) that, after the housing start increases of 2011-2012, housing starts in France are collapsing, “France has to face the secular decline of the investment rate”.

Graph 4. The Nordic countries. Interestingly, Finland (an export booster) is also among the worst performing of the European countries, while Sweden did much better – until the saving rate of households sharply increased, post 2010 (from 11,3 to 14,9% of “gross saving (ESA95 code: B8G) divided by gross disposable income (B6G), with the latter being adjusted for the change in the net equity of households in pension funds reserves (D8net)“). Note the Finnish bubble.

Graph 5. Italy and Spain. Note the Spanish bubble. Note that Spanish policies aimed and depowering and defunding households (as well as governments…) in Italy and Spain did not lead to any kind of solution.

Summarizing: the rich countries are plagued by a post 1970 secular decrease of the fixed investment rate. Policies aimed at increasing savings to raise the investment rate will fail, as this decline is not caused by short-term supply side or even demand side factors but by changing historical circumstances. Policies enabling households to make investments (classified as ‘consumption’ in the national accounts!) into life cycle proof houses, cars, or even electric bicycles. Be aware: ‘life cycle proof’ is not just a technological but also a social concept as it might mean that a new ‘phase of life’ will have to be ‘discovered’, which consists of elderly living independently together under one roof in ‘lame and blind’ houses for some years.

Sources: Eurostat, Bureau of Economic analysis, Bank of Sweden, Bank of England, Centraal Bureau voor de statistiek, European historical statistics, The Cambridge Economic History of Europe VII part 1 and part 2, Gallman, R. E. (1986), ‘The United States Capital stock in the nineteenth century’ in: Engerman, S.L. and R. E. Gallman, Long-term factors in American Economic growth pp. 165-214. University of Chicago Press.