Business investment 'limping along'

I tend to focus a lot of attention to analyses of trends in the U.S. consumer sector data, and my reasoning for this is simple. The consumer sector accounts for approximately two-thirds of the total U.S. GDP, and the trends in many major end markets for plastics products — automotive, packaging, appliances, etc. — are dependent on trends in consumer spending.

The consumer is king in America, but I cannot ignore the business sector. Business fixed investment accounts for roughly 13 percent of the GDP total, which amounted to almost $2.9 trillion in 2019. Many segments of the business sector purchase plastics products of some type, and all of the spending for plastics machinery and tooling is counted as fixed business investment. So the trend in business spending also affects plastics industry data.

At this particular moment in time, the trend in business spending is an important story. It is not an overstatement to say rising investment is the only way the American economy can create jobs, steadily raise its standard of living and ensure the blessings of prosperity for ourselves and our posterity. Unfortunately, the latest data indicate total business fixed investment in the U.S. has declined for three straight quarters.

Before I get too deep into the analysis, let me explain what is meant by "fixed investment." Simply put, it is the spending on things that belong to the business. It includes supplies, structures, equipment and intellectual property. Most businesses also invest a lot in the form of payroll and other benefits, but for GDP accounting purposes, this gets counted as household income and it is included in the consumer sector statistics.

On the chart I have graphed the spending levels by U.S. businesses for the three major categories tracked by the Bureau of Economic Analysis: equipment, intellectual property and structures. All of the data is adjusted for inflation.

There are a few things that jump out to me on this chart.

For the short-term outlook, the things that cause concern are the recent downward trends in the investment levels for both equipment and structures. Focusing just on the equipment graph, the total hit a peak in the second quarter of 2019 and then trended down during the second half of last year. The decline was not severe, and the annual total for all of 2019 still managed to post a gain of more than 1 percent when compared with the tally from all of 2018.

Nevertheless, the trend in equipment spending entered 2020 with negative momentum. This trend becomes even more worrisome when you factor in the fact that interest rates have been at historically low levels in recent months and the stock market is at all-time highs. In the past, low interest rates and a strong stock market were usually accompanied by a rising trend in equipment spending. But now it seems we are just limping along. I expect this trend to return to positive later this year, but the gains will be moderate at best.

From a longer-term perspective, I am pleased to see the solid trend upward in the equipment graph. The average rate of growth in equipment spending during the past 10 years has been an impressive 7 percent per year. Most of this growth has been powered by strong gains in spending for information processing equipment (computers), but the increases in spending for industrial equipment, including plastics machinery, have also been respectable. I can live with the fact this chart will experience some short-term fluctuations, but our long-term national strategy must be for consistent gains.

As for the graph on investment in structures, the trend is not encouraging. Business investment in structures hit a recent cyclical peak in early 2018, and the trend has been downward since. The annual total in 2019 declined by more than 4 percent when compared with the year before.

Equally disappointing is the trend over the past decade: Business investment in structures has stayed mostly flat for the past 10 years. I expect this category to remain a drag on the overall total for a while longer. Somewhere over the horizon, a strong program of government spending on new infrastructure could spur private investment in new structures. But, for now, I do not see a catalyst for a large-scale increase in new investment for structures.

The middle line on the chart tracks spending for intellectual property, and this has clearly been the strongest category in recent years. In 2019, investment in intellectual property jumped nearly 8 percent when compared with the level from 2018. Over the past 10 years, investment in IP has averaged growth of more than 5 percent per year, but the trend is accelerating.

Intellectual property is the category that includes research and development spending as well as investment in new software. Strong and consistent increases in spending in both of these segments are critical for our nation's future prosperity.

One final observation from this chart is how much business investment has changed in just the past decade. Ten years ago, the allocation was pretty evenly distributed amongst these three categories. Now it is heavily skewed toward investment in information processing equipment. But the rapid growth for spending on intellectual property may push it to the top spot before another 10 years pass. I expect these long-term trends to persist.