Eric Van Nostrand,Assistant Secretary for Economic Policy (P.D.O.)
Much economiccommentaryfocuseson the historically strong job market, which has supported solid consumer spending and overall growth. But another key component of a healthy economy—one that tends to be more forward looking than consumer spending—is business investment.Foraprosperous corporate sectorto truly benefit families and workers,businesses mustfeel confidentinvestingtheir profits to generate newjobs,opportunities,and innovations.American businesses are doing well not simply because theirearningsare high, but because they are investing thoseearningsproductively.
Creatingfavorable conditions for business investmentis central to President Biden’s economic agenda. TheCHIPS&ScienceAct and Inflation Reduction Actexplicitly encourage private investment,while otherAdministration effortsincrease competition and reduce barriers to entryfor new firms.Business investment strengthens our economy’s long-run productivity while creating space for higher-quality jobs.This blog reviews the progress of U.S. business investment since the pandemic.Our key conclusions:
- Americanbusiness investmentisoutperforming expectations inthe post-pandemicexpansion;businesses have invested $430 billion more this cycle than if investment followed historical patterns.Despite high interest rates that increase firms’ borrowing costs,realU.S.business investment has outperformed three key benchmarks: typical behavior in economic expansions, post-COVID consensus forecasts, and the conventional accelerator models that economists use to forecast investment.
- Factory building (construction for manufacturing) has contributed almost one third of business investment growth since the pandemic.This is a departure from the norm:manufacturingconstructiondid not contribute to business investment growth on average from 1973 to 2021. Intellectual property investment has also grown, while conventional equipmentinvestmenthas slowed.With factory building concentrated in the computer, electrical, and electroniccategory that includes semiconductors and electric vehicle batteries,theCHIPS Act and the Inflation Reduction Actare likely drivers.
- The outlookfor future business investment growthisencouraging:firms are observing persistently high returns to their capital, and founders are starting new businesses at historic rates.Today’s persistently high returns to capital give businessesconfidence that their investments will pay off in the futureandweaken the argumentthat public investments are crowding out private capital.Business founders are showing confidence in the investment outlook, as applications for new businesses surge above pre-pandemic rates.
Post-COVID Business Investment Growth
U.S. real non-residential fixed investment (“business investment” hereafter) hasgrownat a relativelyconsistent rate of 4-6 percentper yearsince 2021, largely consistent with the pre-COVID business cycle.But despite the consistency with the historical trend, post-COVID business investment growth has outperformed three keybenchmarks: historical business cycle behavior, economists’ forecasts, and economic modeling.
Because the 4-6 percentfigure alone is notespecially high by historical standards,a casual observer might be forgiven for characterizing thatinvestment growthas middling. Indeed, the pre-pandemic conversation around business investment focused heavily on a global slump relative to historyand expectations.1
Butthe macroeconomic context after the pandemic is considerably different, and would normally lead one to expect lower investment.Theoretically,high interest ratesraise firms’ borrowing costs and are typicallyexpected to slow investment growth.Higher uncertaintyaround macroeconomicforecastsin the post-pandemic expansionshould alsohave slowedinvestment.Butinstead, business investment growth hasmaintained its historical strength.
First, the historicalbenchmark. Figure 1showsbusiness fixed investment as a share of GDP since the COVID business cycle peak (blue), compared with the analogous period in the Great Recession and Recovery (orange), and the average behavior in all U.S. business cycles since 1971(dotted).Typically, investment tends to fall as a percent of GDP in a recession and to continue to contribute less well into the recovery. This was especially the case in the 2008 Great Recession, when business investment as percent of GDP fell by more than 2 percentage points. In recent years, business investment has bucked that trend, remaining at roughly the sameshare of GDP since before COVID: a better outcome than after every other recession since 1980.Indeed, in this cycle, American businesses invested$430 billion more than ifoverall growth had been the same butinvestment followed its usual historical pattern.2
Figure 1
Notes:Business cycle peaks are the National Bureau of Economic Research’s quarterly business cycle peaks. “Business fixed investment” is private nonresidential fixed investment.
Source: Bureau of Economic Analysis;National Bureau of Economic Research; U.S. Treasury calculations.
A secondbenchmark:whatdideconomic forecastersexpectfor business investment growth earlier in the cycle?Figure 2 shows actual calendar-year growth in business investment (blue bars) for 2022-2024, alongside the Blue Chip consensus forecasts forOctober 2022 (green bars). InOctober 2022,the Federal Reserve’sinterest rate hikes were wellunderway and markets expected persistently higher rates. Actual business investment growth outperformed each of these forecasts from2022to2024to date.
Figure 2
Notes: Actual Investment Growth reflects the actual annual average growth rate in private nonresidential fixed investment.Blue Chip Forecasts are the consensus forecast for the same reported by Blue Chip Economic Indicators in October 2019 and October 2022.*For 2024, an estimate of actual growth is shown assuming that the reported growth rate in the first quarter of 2024 persists throughout the year.
Source: Bureau of Economic Analysis; Blue Chip Economic Indicators.
A thirdbenchmark:what canwelearn from the conventional modeling tools economists use to understand the drivers of business investment?These models form the basis for the forecasts described above, but by examining their details we can see which economic variables are responsible for the investment's faster-than-forecast recoveryafter the pandemic. Figure 3 compares business investment growth with the output of a conventional “accelerator model,” a concept first proposed by Alvin Hansen in 1938.3Accelerator models hold that business investment growth is related tochangesin overall output growth:that businesses invest morewhen the economy grows faster. In theimmediatepandemic recovery, these models predicted a quick rebound in investment. But since the economy has cooled from that initial burst of growth,the modelshave called for slower investment growth as shown on the right side of Figure 3. But actual business investment has nonetheless maintained that stable 4-6 percent growth rate.
Figure 3
The Role of Factory Construction in Business Investment
To help identify the drivers of historically resilient business investment,Figure 4 shows the contributions to business investment growth over the past few decades by type of investment.Overthe 35 years leading up to theGreat Recession(left bar) and the 12 years following theGlobal Financial Crisis, theaveragecomposition of business investment growth was largely consistent: significant contributions from investment in equipment and in intellectual property, with some varying contribution from changes in structures investment (construction) in non-manufacturing sectors. Investment in manufacturing structures (factory construction) made no contribution on average. Butin recent yearsthe composition of business investment growth looks quite different: factory construction has contributed almost one-third of business investment growth sincethe end of 2021.
Figure 4
Notes: Growth in private nonresidential fixed investment is decomposed into contributions from equipment, intellectual property, manufacturing structures, and other structures over the indicated time periods.Contributions are inferred from the given subcomponents’ published contributions to private fixed investment growth, and then scaled by the ratio of private nonresidential fixed investment growth (BFI growth) to BFI growth’s contribution to overall private fixed investment growth.
Source: Bureau of Economic Analysis; U.S. Treasury calculations.
The surge infactory construction is well documented:spendinghas more than doubled in real terms since 2021as shown in Figure 5, as we detailed here6last summer, and it hasfurtherincreasedsince then. Of course, one should not expect this surge to continue in perpetuity,soits contributions to business investmentgrowthshould dwindle. But it has reflected a new kind of private investment that helps explain the resilience of overall business investment.
Figure 5
Data from the Census Bureau allows us tofurther decompose the surge in manufacturing construction. Figure 6 compares the composition of real manufacturing construction spending onaverage from 2005-2022 to the average since the beginning of 2023. Factories in “computer, electrical, and electronic” manufacturing are the obvious source of the surge—a category that includes semiconductors and electric vehicle batteries. This isconsistentwiththe CHIPS and Science ActandtheInflation Reduction Actachievingtheiraim of encouragingprivate investmentinsemiconductor manufacturing.
Figure 6
Outlook for Future Business Investment Growth
In a simple model of business investment, firms will invest capital where they expect to receive the highest risk-adjusted return relative to saving the capital or returning it to shareholders. All elsebeingequal, higher interest rates make the alternative of saving more appealing, and might be expected to slow investment. But the stellar performance of business investment in recent years suggests firms have confidence their investments will earn high returns. Here, we share two pieces of evidence that firms are expecting higher returns to investment: returns to all private capital remain historically high (suggesting that firms can expect to earn significant profits from investing rather than saving), and applications for new businesses are surging (suggesting that founders expect historically high rewards from going into business). Both these points should give observers more confidence in continued strong U.S. business investment growth.
Returns to Private Capital Are Historically High, Encouraging Investment Today
First, estimates of the return to all private capital remain historically high; observing these high returns gives businesses confidence that their investments will pay off in the future. Perhaps best understood as the “aggregate return on all private investment,” the return to all private capital reflects the total returns generated by the full capital stock of the United States. Estimates vary, but Figure 7 uses the methodology developed in Furman (2015). This measure of the return to private capital has hovered around 7 percent since 2015, a figure that remains well above today’s elevated borrowing costs.
Figure 7
Notes: The return to all private capital is measured as in Furman (2015), as the private capital income as a percent of the prior year’s private capital stock. Private capital income is defined as the sum of 1) corporate profits ex. federal government tax receipts on corporate income, 2) net interest and miscellaneous payments, 3) rental income of all persons, 4) business current transfer payments, 5) current surpluses of government enterprises, 6) property and severance taxes, and 7) the capital share of proprietors’ income, where the capital share was assumed to match the capital share of aggregate income. The private capital stock is defined as the sum of 1) the net stock of produced private assets for all private enterprises, 2) the value of total private land inferred from the Financial Accounts of the United States, and 3) the value of U.S. capital deployed abroad less foreign capital deployed in the United States.
Sources: Bureau of Economic Analysis (Fixed Asset Accounts); Federal Reserve Board (Financial Accounts of the United States); U.S. Treasury calculations.
This calculation is only available through 2022, but strong corporate profit growth and high recent returns in public equity markets, even relative to higher interest rates, suggest that businesses are observing no slowdown in returns available in the market.
Anotherimportant pieceevidence that firms expect higher returns to investment is that more Americans are starting firms.Thenew establishment birth rate, or the number of new firms as a share ofexisting firms,which had been largely stagnantbutrising gradually since the Great Recession, surged after the pandemic,and peaked at an all-time high in 2022. It has since been normalizing, but remains above pre-pandemic rates. More start-ups suggests that more foundersexpect strongreturnsfromstarting businesses than otherwise.
Figure8
Note: Thenew establishment birth rateis calculated from the U.S. Census Bureau’s BusinessEmployment Dynamicsdatabase. It is measured as the number ofnew establishments as a share of all establishments in the United States.
Source: U.S. Census Bureau.
For a moreforward-lookingread on the propensity to start businesses, though, we can observe the new business applications data from the Census Bureau’s Business Formation Statistics. There has been a structural break in the rate of new business applicationsreceived since the pandemic,withthe monthly rate rising from just under 300,000 per month in 2018 and 2019 to between 400,000 and 500,000 per month in the past two years, as shown in Figure9. The magnitude and persistence of the change in business application ratesafter the pandemicremains something of a puzzle. But it is an encouraging signal that the post-pandemic business climate in the United States isleading more to invest their time, efforts, and capital in the American economy.
Figure9
Source: U.S. Census Bureau, Business Formation Statistics.
Conclusion
Betweenmacroeconomic data and impressive progress at the micro level, there are many reasons for optimism around the business investment outlook. The Administration’s growth agenda is focused not on boosting demand in the short term, buton improvinglong runproductivitybyencouraging Americancompaniestoinvestinour capacity to produce. That is a central element of the strategy Secretary Yellen has called “modern supply-side economics,” reflecting a recognition that the next phase of economic growth will involve building a productive economy that can address our biggest challenges.
The resilience of investment since the pandemic reflects the impact of thisfocusalready, as the Administration’s policies encourage a rebound in strategic sectors like manufacturing and clean technology. Many questions remain about the relationship between this modern industrial strategy and conventional investment growth, butso far the results are encouraging.Thesepoliciesarehelping create space and confidence for more Americans to invest their time, labor, and capital in strengthening our economy.
[1] For example, see Jason Furman, Business Investment in the United States: Facts, Explanations, Puzzle, and Policies(2015) and the International Monetary Fund’s 2015 World Economic Outlook Chapter 5, Private Investment: What’s the Holdup?
[2]Actual business fixed investment from 2020:Q1 to 2024:Q1 was $14,054 billion, when summed over periods. As a counterfactual, we measure what business fixed investment would have been if actual nominal GDP figures were realized over that period, but business fixed investment as a share of GDP followed the average pattern depicted in the dotted line in Figure 1; this is $13,627 billion, for a difference of $427 billion.
[3] Alvin Hansen, Full Recovery or Stagnation? (1938).
[4] Jorgenson, Dale and Calvin Siebert. 1968. "A Comparison of Alternative Theories of Corporate Investment Behavior." American Economic Review, Vol. 58(4). 681-712.
[5] International Monetary Fund World Economic Outlook 2015: Private Investment: What’s the Holdup? Appendix 4.5.1.
[6] Van Nostrand, Eric, Tara Sinclair, and Samarth Gupta. "Unpacking the Boom in U.S. Construction of Manufacturing Facilities." U.S. Department of the Treasury. June 27, 2023.
