A newly released Bank of Canada Staff Discussion Paper explores why the recovery in private business investment globally remains extremely weak more than seven years after the financial crisis.
The global financial crisis resulted in a broad-based collapse of business investment, with the level of investment falling well over 10 per cent in most member countries of the Organisation for Economic Co-operation and Development (OECD).
An uneven recovery followed, led by oil-exporting regions, which benefited from a rebound in energy prices. The post-crisis recovery in business investment has been underwhelming. Annual investment growth in OECD countries averaged a mere 2.2 per cent between 2010 and 2014, compared to around 3.5 per cent in the decade leading up to the financial crisis.
The bulk of this weakness was unexpected, and has resulted in investment consistently underperforming relative to forecasts of both public and private forecasters. Over the past few years, several institutions, including the OECD, the International Monetary Fund (IMF), the Bank for International Settlements and the Banque de France, have investigated this “investment puzzle” to identify some of the factors that standard models might fail to capture.
This paper contributes to the ongoing policy debate on the factors behind this weakness by analyzing the role of growth prospects and uncertainty in explaining developments in non-residential private business investment in large advanced economies since the crisis. Augmenting the traditional models of investment with measures of growth expectations for output and uncertainty about global demand improves considerably the ability to explain investment growth.
Our results suggest that the main driver behind the weakness in global investment in recent years is primarily a pessimistic outlook on the part of firms regarding the strength of future demand. Lower levels of uncertainty have supported investment growth modestly over 2013–14. Similarly, diminishing credit constraints, lower borrowing costs and relatively stronger corporate profits have also supported the recovery in business investment from 2010 onward.
Our findings have two important implications for the global outlook for investment. First, the expected improvements in global growth should support a recovery in investment; however, a slowdown in growth in emerging-market economies or further growth disappointment in advanced economies could restrain this recovery. Second, the ongoing recovery in investment remains vulnerable to uncertainty shocks.
Note: Bank of Canada staff discussion papers are completed staff research studies on a wide variety of subjects relevant to central bank policy, produced independently from the Bank’s Governing Council. This research may support or challenge prevailing policy orthodoxy. Therefore, the views expressed in this paper are solely those of the authors and may differ from official Bank of Canada views. No responsibility for them should be attributed to the Bank.