Investment: A Rush for the Entrances?

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

Sadly, we are too familiar with stories of a mad rush for the exits. Panic can incite a stampede that leaves many hurt, or worse. The economy has seen its share of these in the past seven years. Less frequent is the rush for the entrances. Football games and rock concerts have seen these, but economic inbound rushes don’t quickly come to mind. Do they occur, and if so, are they at all relevant to current conditions?

Business investment spending is a wild and unpredictable beast. The best we can say is that it reacts to economic movements with a considerable lag. But the size and speed of the lag are often a surprise. Models miss the movements by large factors, and elaborate attempts to narrow the errors are usually fruitless. A solid knowledge of project pipelines is as good as any model, but even this approach is vulnerable to large new announcements. So much for short-term movements; is it possible to get a handle on the overall cadence of business investment? It does generally follow the economy, and the past cycle tells a story that gives clues on possible near-term shifts. What are some of the key observations?

When the economy is in overdrive, firms over-invest. The average business wants to capitalize on business that’s out there. Even if there are worries that there’s a bubble going on, no one wants to miss out on the fun. This happened at the end of the last economic cycle, most obviously in the US economy, leaving firms with a cavernous excess of spare productive capacity. Clearly, over-investment isn’t today’s problem.

When the economy is down, firms under-invest. Makes sense – who needs to invest when there is a lot of spare capacity? In order to survive, firms cut back as much as they can, adjusting to the new economic ‘reality’. If this ‘reality’ lasts long enough, as in the present 6-year investment lull, firms can easily get duped into thinking that the muted investments they are doing are enough to see them through. In the case of the US, weak investment has put pressure on existing capacity to the point that there is very little left. Across their manufacturing sector, capacity utilization is almost back to the pre-crisis, frenzied-economy peak – only the economy is hardly frenzied at present. Sounds like they are staring down a capacity crunch. In principle, this is nothing new, but this time around the scale is a lot greater, given the length of the post-crisis stagnation. This gives rise to another investment truism.

When the investment cycle resumes, it’s all-in. Many firms go through near-death experiences when recession hits. That makes them all the more reluctant to kick-start investment when recovery arrives. The decision to ‘go for it’ is conditioned by what ‘the Joneses’ are doing. Nobody wants to be first to plunge in – but when one or two do, it seems everyone joins. This time around, the frenzy will be magnified. Why? With capacity as tight as it is stateside, a broad swath of firms and industries need to invest, and soon. And when the rush begins, firms soon discover that the capacity to create additional capacity is also very tight – so those first in line get served, and others have to wait. Here’s where the rush for the entrances gets most intense.

So, is it all-in for all industries? Some may take comfort that plunging commodity prices are freeing up resource-sector capacity – room that can be used by others. Not so fast; the oil and gas and mining sectors are restructuring, but in large part project cancellations are only temporary. They are the crisis that sparks renegotiation of contracts. Witness the many projects that are now viable at much lower world prices, and the extent of rumoured or actual resource sector mergers and acquisitions.

Investment is global. More than ever, commercial activity is borderless. As such, America’s constraints stand to spread its rush for the entrances worldwide. In effect, the doorway has widened. Those with capacity stand to gain the most.

The bottom line? Nobody has been lining up to see the business investment movie for the best part of a decade. But it’s about to become a blockbuster, and for all concerned, now’s probably the time to get a ticket.


JULY 2018

Vol. 12 - No. 12


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