An economy’s potential growth rate is the rate at which it can expand while keeping employment steady and inflation stable. Many economists expect potential U.S. growth to slow to roughly 2 percent each year versus the 3 percent or so we’ve experienced in recent decades.
We’ve considered how slower growth in America’s labor force and productivity (how efficiently we use our resources) translate into slower potential growth. Today we’ll look at the third leg of the stool – investment.
Investment is the spending private businesses make on buildings; equipment; patents, copyrights, and other intellectual property; research and development; and inventories.
Government also invests – in infrastructure such as roads, dams, seaports, and airports; basic scientific and medical research (e.g., NASA and the National Institutes of Health); buildings, furniture, and transportation fleets; and a wide array of defense equipment.
But all forms of investment aren’t created equal.
Although it can be hard to draw a bright line between investment types, they generally fall into one of two categories. One type of investment is considered to be “productive investment,” meaning it will generate a future stream of production, income, and profits, or otherwise improve U.S. productivity.
When a business builds a new factory or expands an existing one, while also installing new equipment and computer technology, that business is putting in place the means for expanded production, income, and profits in the future. And that translates into expanded economic growth for the United States, especially as many such investments are made by businesses across America.
When federal, state or local governments spend money to improve a highway or irrigation system, many businesses, farms and ranches, and individuals benefit through faster transportation, improved water delivery, and reduced repair bills for cars and trucks.
As with private investments, those public infrastructure improvements often translate into greater efficiency and improved production and profits for users.
Another type of investment is considered to be “nonproductive.” Even though it may create jobs and income today, it does not generate a future production and income stream that will translate into higher future growth. Housing and certain other types of real estate fall into this category.
U.S. investment, both private and public, has grown more slowly in recent years and especially since the recession, when it plummeted for understandable reasons. What is less understandable is why private investment levels have remained so low, even as the U.S. economy has continued to pick up steam.
After-tax corporate profits are near historic highs, but those profits haven’t translated into equally high levels of new investment.
A large share of profits is being returned to shareholders as dividends or used to buy back stock. These moves often bolster stock values in the short term. But this trend would be worrisome if it continues, because it means we’re not investing in our future as much as we probably should.
Of course, there are other reasons why businesses may not invest as much as before. Consumer demand here and abroad remains weaker than before the recession. Companies may hold profits overseas for tax reasons. And low oil prices hurt investment in oil and gas production.
While the real estate sector is a very important one in the U.S. economy, too many of our investment dollars before the recession went into residential real estate. This over-investment not only contributed to the housing bubble that burst in 2008, but it also meant an under-investment in more productive outlets.
Finally, public investment in 2013 fell to the lowest share of our economy than at any time since World War II. It has not changed much since then, due to budget constraints that hit government investment as well as consumption. Our crumbling roads, bridges, and other infrastructure hurt America’s competitiveness vis-à-vis other countries.
What difference does it make if our economy grows slower in the future? If it means less use of fossil fuels, wouldn’t that help in the global battle against climate change? And even the pope expressed concern about over-consumption.
Slower growth here and around the world certainly could ease pressure on the environment. And there is no magic rate at which our economy should grow. But slower growth also implies lower job creation and slower increases in our standard of living.
Most importantly, though, slower economic growth will make it more difficult to fulfill promises made to seniors, veterans, and other beneficiaries of our social programs. Finding ways to make ends meet on programs taking an ever larger share of our public budgets will be an increasing challenge in a slower growth environment.
Joanna Shelton was deputy secretary general of the Organization for Economic Cooperation and Development OECD in Paris; held senior positions in the executive branch and Congress in Washington, D.C.; and teaches at the University of Montana. You can reach her through her website, joannashelton.com.