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Business Investment: Ready to Roll?

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By Peter G. Hall *
Vice-President and Chief Economist Export Development Canada

The economic and financial meteorite that crashed into the world economy back in 2008 left a massive crater. Since then, policymakers have been scrambling to fill it in. All the while, many have cast a wistful, sardonic or resentful eye at a glaring anti-crater: the mountain of money accumulating on corporate balance sheets. Despite appeals to part with a part of the pile, it has only grown. Will corporations ever start to spend, or is the penny-pinching a permanent legacy of the crisis?

America’s corporate cash-stash has been the most obvious. Hovering at US $4 trillion from 2006-08, cash and near-cash balances in financial and non-financial institutions ballooned to US $6 trillion in the following three years, and remain at that level now. That’s a lot of growth, but is it really a mountain? Actually, it adds up to a whopping 38 per cent of US GDP, and the change in the past four years on its own is almost 9 per cent of GDP. Clearly it wouldn’t take much of this to make a dramatic mark on near-term GDP growth. Can we expect the floodgates to open anytime soon?

Post-crisis, corporations decided to sit on their cash for a number of reasons. First, growth prospects were thin, so cash conservation seemed prudent. Crisis itself was likely another motivator – better to have cash on hand for contingencies or adverse developments. Third, for their part, financial institutions were hardly in a lending mood, preferring, and in not a few cases, required to build up their capital bases. Market psychology is perhaps a more recent motivator. Multiple frustrated attempts to restart growth has likely created a “you first” investment mentality that has few takers.

But these factors are more speculative elements of business investment. A more tangible signal is actual capacity. Businesses invest when they need to. As orders rise, production capacity in a low-investment environment gets soaked up – sometimes pretty quickly. Nightly news would convince most that the US is a long way from full capacity. Guess again. A huge capacity chasm opened up in 2009, but production growth since then has bridged about 90 per cent of that gap. The good news? It has already spurred US investment spending, both on equipment and more recently on buildings.

Will investment growth continue? Money doesn’t seem to be an issue. And while outlays for plant and equipment have risen, they’re not keeping pace with demand. Through late 2012, capacity utilization continued to climb, a signal to corporations that investment actually needs to intensify. That’s great news for an economy that is already seeing glowing stats from the housing and consumer sectors.

Are other economies doing the same? The corporate cash stash has grown around the world, but in the largest economies, the capacity story is different from America’s. In the EU, capacity utilization initially recovered more quickly, but has since sunk to uninspiring levels and is currently directionless – hardly a prescription for imminent investment growth. Japan’s story is much the same.

Thankfully, capacity utilization in Canada is more like the US pattern, although the gap has not closed as quickly. This suggests that the corporations north of the border may not be as quick to dip in to the nest-egg. That said, investment is one of the more responsive indicators, and should a US investment spending frenzy occur, Canada – and other parts of the world – could quickly join in.

The bottom line? Evidence shows that an acceleration of US business investment is in the works. Given cash-bloated balance sheets, much more is possible – with positive effects here and abroad.

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