The Decline of American Investment
Politicians from both sides of the aisle are warning of a disturbing trend: a decline in investment spending by America’s companies. Senator Marco Rubio published a report blaming “shareholder primacy” and “corporate short-termism” for “tilt[ing] business towards returning money quickly and predictably to investors rather than building long-term corporate capabilities.” Elizabeth Warren echoed his sentiments: her Accountable Capitalism Act claims that dedicating earnings to shareholders has “redirected trillions of dollars that might have otherwise gone to workers or long-term investments” and that “there is an urgent need to return to the era when American corporations produced broad-based growth.”
These Senators are correct in their observation of the state of business investment. The share of revenues corporate America invests in capital expenditures has declined significantly from 10% of sales in 1980 to 6% of sales in 2015.
Figure 1: US Capital Expenditures Net of Depreciation, 1980–2015
Source: Credit Suisse HOLT. (Note: Dollar amounts are not inflated)
But this is only part of the picture: there are two big reasons to think the story might be more complicated than the graph above suggests.
First, as our economy has grown more prosperous and efficient, the cost of capital goods has declined. Economists estimate that the cost of machinery and equipment has fallen about 40% in developing economies, led by a 90% drop in the cost of computing equipment.
Figure 2: Relative Price of Capital Goods
Source: Eichengreen (2015)
Economic progress and global trade have reduced the cost of a wide variety of capital goods, including most machinery and equipment, transportation, and even intellectual property. The latest iPhone XS, which costs $1,000, is 120 million times as powerful as the first Apollo Guidance Computer, which would cost $1.5 million in today’s dollars. The first microwave oven cost $3,700 in today’s dollars ($495 in 1967), whereas a typical model is about $150 today. The 40% drop in the cost of capital goods would explain the entirety of the decline in investment shown in figure 1 and more.
Second, the decline in fixed investment reflects a shift in the economy from manufacturing to technology and pharmaceuticals. Since 1980, healthcare and technology have gone from 18% of US equity market cap to 34% while energy, materials, and industrials have fallen from 50% to 19%. Healthcare and tech firms spent a combined 60% of all R&D expenditure in 2018, while industrials, auto, chemicals, and energy added up to 31%. And while fixed asset investment has declined, R&D expenditures have sharply increased. The share of revenues corporate America invests in R&D has increased significantly from 1.3% of sales in 1980 to 2.7% of sales in 2015.
Figure 3: US Research and Development, 1980–2015
Source: Credit Suisse HOLT. (Note: Dollar amounts are not inflated)
Due to accounting rules, research and development is counted as an operating expense not an investment, but it’s the primary form of investment for some of America’s leading industries. This shift in investment spending could explain about a third of the decrease in capital expenditure observed in figure 1. It’s possible that combining these two effects investment has actually increased.
So most of the decline in investment isn’t a story of rapacious capitalists destroying our economy, but rather a more productive and technologically sophisticated business world that doesn’t require as much spending on machinery and equipment.
Nonetheless, Rubio and Warren are also right in arguing that shareholders don’t like investment spend, and with good reason. A wide body of academic literature suggests that overspending on capital expenditure is for a risk for both investors and businesses. Investment spending tends to be highly correlated with the economic cycle, the recent stock performance and valuation of the company, and the confidence of the CEO—and negatively correlated with future stock price returns. This makes a lot of sense: companies that have been doing well recently should be able to attract cheaper capital and should have a stronger belief in their future growth trajectory, but if growth is unpredictable and markets mean reverting, this behavior should be pro-cyclical - and often excessive.
So we can worry less about the decline in investment spending in the American economy, which is probably a good thing. And we should worry instead about the opposite: over-confident CEOs squandering money on losing investments.