Published December 27, 2012
LONDON – Five years into the great financial crisis, private investment in rich countries is still dead in the water, underlining the depth of the downturn and offering fresh evidence of the global economic tilt to emerging markets.
By 2011, private investment as a share of 2007 GDP had fallen 3.4 percent in the United States, 3.8 percent in Japan and 2.9 percent in the 27 countries of the European Union, according to data compiled by McKinsey Global Institute (MGI), the consultancy firm's research arm.
No other component of GDP dropped anywhere near as sharply in any of the three economies. Investment is the seed corn of growth, so the consequences are potentially ominous.
"The slump in investment in Europe is not only constraining current GDP growth but could also cause long-term damage to the continent's economic capacity," MGI said in a report analyzing the dearth of investment in Europe.
On one level, it is not surprising that businesses are pulling in their horns.
Uncertainty about U.S. tax and spending policy, questions about the very future of the euro zone and Japan's shrinking population are all good reasons to give managers pause for thought before expanding anew after the deepest global recession in 80 years. Consumer confidence is low.
On another level, though, the extent of the retrenchment is puzzling. Businesses are sitting on huge cash piles and profits have risen sharply as a share of GDP in the United States, Japan and Canada.
Yet private investment in the EU is today nearly 15 percent below its 2007 level. Only in Poland has it risen. In Spain and Ireland, hard hit by the euro zone crisis, private investment has slumped 27 percent and 64 percent respectively. But Britain and France have also recorded sharp falls.
Overall, MGI calculates, non-government capital spending in the EU between 2007 and 2011 shrank by an unprecedented 350 billion euros -- 20 times the drop in private consumption and four times the decline in real GDP.
While Germany, Belgium, Austria and Sweden have almost joined Poland in regaining pre-crisis investment levels, the EU as a whole is running well behind the average rate of recovery based on an analysis of past recessions, according to MGI.
In Greece and Spain, private investment had not yet begun to rise again by the end of 2011.
Economists Stephen King and Madhur Jha at HSBC said rising tax burdens as well as prolonged economic weakness might explain why corporate profitability, and hence investment, has been hurt in countries such as Britain and Germany.
But that argument does not hold water for America and Japan.
King and Jha hypothesized that multinational companies are ploughing capital instead into more attractive emerging markets, especially developing Asia, where investments as a share of profits have continued to rise sharply.
If they are right, it would be another example of how the centre of economic gravity is switching to East from West.
"As the ���old world' has to deal with the myriad uncertainties of the post-crisis world, the global economy is going through a period of profound restructuring which has undermined the traditional rules of the economic game," King and Jha wrote in a report.
So what can be done?
IN SEARCH OF INCENTIVES
Andrew Smithers, who runs an eponymous consultancy in London, has long argued that executives in the United States and Britain have no incentive to invest for the long term in plant and machinery because their pay packets are linked to short-term shareholder returns.
"In both countries the bonus culture means that management is paid not to invest and to keep profit margins high," he told clients. Reform is needed.
With government budgets tight, debate is intensifying on how to catalyze more private spending on infrastructure such as power and transport.
Britain is toying with the idea of introducing more widespread motorway charging to unlock investment by regulated private operators.
Georg Zachmann with Bruegel, a Brussels think tank, suggested a temporary role for publicly owned banks to mitigate the increased post-crisis risk of infrastructure investment.
At the EU level, a pilot program for the issuance of up to 230 million euros in government-guaranteed project bonds could be ramped up to lower the cost of borrowing, Zachmann added.
McKinsey Global Institute does not want a return to the days when government tried to ���pick winners'.
But it sees substantial scope to accelerate capital spending in Europe by cutting red tape. For instance, the consultancy believes that private investment is available and ready to finance the expansion of airport infrastructure if regulatory barriers were removed.
Retrofitting existing buildings and improving the energy efficiency of new buildings, to help Europe meet its 2020 energy targets, could lead to roughly 37 billion euros a year of extra investment, MGI said.
In retailing, planning rules in many countries limit the growth of more-productive large-format stores; in construction, fussy specifications make some projects inefficient and expensive; in transport, there are 11 separate signaling systems for rail freight in the original 15-country EU core.
"Twinning macroeconomic policy with microeconomic reforms can help to ensure that companies revive their investment plans on a sufficiently large scale for their spending to become a material driver of a robust recovery," MGI concluded.
(Editing by Mike Peacock)