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We need to fix the collapse in investment expenditure


Dan O'Brien

Dan O'Brien

Dan O'Brien

Investment in the economy's productive capacity is like motherhood and apple pie. Everyone is in favour of it and nobody is against it. It is not hard to understand why.

Spending on physical and human capital generates economic activity in the here and now – building a new road leads to employment and wages for construction workers and juicy contracts for businesses up and down the supply chain. But it also increases the capacity to generate wealth in the future – time saved for individuals and businesses by using better roads lowers costs, leading to more economic activity, all other things being equal.

Generally, more investment leads to more wealth now and in the future.

One of the many notable features of the Irish crash has been the spectacular collapse in investment expenditure. Both companies and the State have slashed spending on new productive capacity. Of the main expenditure components of GDP, the fall in investment spending – or 'fixed capital formation' in the jargon of economists – has been by far the biggest.

As the first chart shows, by 2012 (the last full year for which figures are available) investment spending as a percentage of GDP was not only at its lowest level since records began in 1970, it was running at around half the long run average.

Separate quarterly figures for the first nine months of 2013 show a further, albeit slight decline compared to the previous year, so there is little sign that overall investment spending is picking up.

The chart also shows how historically low investment has gone. Even in the dismally protracted slump of the 80s and early 90s, spending as a share of GDP never came near current lows.

By standards of other countries the current Irish levels of investment spending are extremely low and a fraction of the biggest investing countries, such as China, where an eye-popping 40pc of GDP is accounted for by capital accumulation.

One of the less bad reasons for that is because the pre-2008 period saw huge over-investment in residential and commercial property in many parts of the country. This shows that investment is not always a good thing. It shows, too, that when considering investment, quality is as important as quantity.

Of the quality investments made during the bubble, the building of a modern road network was among the best.

As the second chart shows, it is only after the turn of the century that any serious money was put into Irish roads. And while spending has been pared back dramatically that is in large part because the motorway network is built.

But there was a great deal of bad investment too. Spending on building commercial property, such as shops and offices, surged in classic bubble-style towards the very end of the mania – 2006-08 – as a belief took hold that such investment could only turn a profit.

Few developments during the craziness illustrate this better than over-investment in hotel capacity, in large part because of dunderheaded tax breaks.

Not only are many now owned by NAMA, but some are providing unfair competition to prudent hoteliers who did not lose their reason during the bubble.

But the greatest folly took place among home-builders. Spending on residential construction surged most up to 2008 and its fall since has been the biggest. From the height of the construction frenzy to 2012, investment in the housing stock fell by 80pc.

As the second chart shows, it is now back at levels last seen in the late 70s.

If it was much too high during the bubble, it is now too low. Given a rising population, particularly in some urban areas, the undershooting of investment in home-building is clear. Calls for the Government to remove obstacles to house-building in areas where it is clearly needed are fully justified and, if that were to happen, the battered construction industry would get a shot in the arm.

The area of investment spending least affected by the bubble was companies' purchases of the capital equipment they need to do business, including such things as factory floor machinery, computers, software, tractors and lorries.

Last week two economists at the Central Bank published a study on patterns of investment in Ireland over decades. Over the shorter term Reamonn Lydon and John Scally found that spending on machinery and equipment did fall significantly over the course of the recession, but that its movement was less amplified than all construction-related investment.

Their drill-down into the numbers also had some good news – there has been a clear recovery in companies spending on such investment since 2011. Among the few good records being broken is the rise in spending on software. It has been rising almost continuously and was hardly affected by the crash. In 2012, it hit another record, with €1.2bn invested.

Among the factors Lydon and Scally count as important in influencing companies' decisions to invest are expectations of future economic growth and asset values. Both are moving upwards and should continue to support more investment.

Less positive is credit availability. With the banking sector still in down-sizing mode, its corporate loan book continues to shrink. Unless something dramatic were to happen – such as the purchase of AIB by a big, well capitalised international bank with real expertise in business lending – the lack of credit availability is likely to hinder stronger business investment for some time to come.

Irish Independent