The investment drought of the last two decades is catching up with us

In all the talk of ‘restoring better’ and making economies ‘fit’, ‘strategically autonomous’ and ‘sustainable’, there is an unspoken but tragic premise. For decades, most advanced economies did not build their future, but languished in an investment drought, the scandal of which is greater if not acknowledged.

Between 1970 and 1989, the share of gross domestic product devoted to investment in six of the world’s seven largest economies averaged from 22.6 percent for the United States to 24.8 percent for Germany. Seventh, Japan, is off the charts at 35 percent.

Of the G7, only Canada has maintained this level of investment: its 22.5 percent this millennium is down slightly from 22.8 percent then. All others managed to match their investment levels from 1970-89 in only four cases: the US in the boom years of 2000 and 2005-06, and France in 2021.

Yet the last 20 years have been an era of ever-lower funding costs, first due to market gluts, then thanks to the ultra-loose monetary policy of central banks. And what do we have to show for all that cheap credit? Two lost decades for investment. As economics writer Annie Lowry succinctly puts it, “we cracked it.”

Line chart of gross fixed capital investment as a percentage of gross domestic product, showing Most rich countries have failed to maintain their levels of investment

France and the US have invested nearly two percentage points of GDP less this century than in the 1970s and 1980s; Germany and Italy with about 4.5 points less; The United Kingdom and Japan, 6 and 10 percentage points less, respectively. Those are huge numbers. The G7 account for about $45 trillion in annual GDP. Restoring their investment ratios could fill almost half of the global shortfall of up to $4 trillion that the International Energy Agency calls for annual investment in clean technologies if we are to reach net zero by 2050.

These are the total investment numbers, but a similar story applies to the public sector itself. In the US, net government investment (after taking into account the depreciation of existing public capital) fell by almost two-thirds in the decade to 2014, when it fell to 0.5 percent of GDP.

Line chart of US net government investment as a percentage of gross domestic product showing worse recovery

In the euro area, net public investment was negative that year, thanks to extreme fiscal constraints in the euro area periphery and a chronic underinvestment in Germany.

Some will be tempted by claims that we should not worry. It’s normal to invest less as you get richer – so goes one argument – because adding to an already large capital becomes increasingly worthless. The price of capital goods has fallen, so the same money buys you more real investments, says another. Third is that the current economy needs intangible rather than physical capital, and although this is harder to measure, countries seem to be doing better on this front.

Yet such assurances, even if real, are worthless. No one who looks closely at the physical infrastructure of most Western countries can think it is fit for purpose – not when that purpose is expanded to include decarbonizing our industries and energy and transport systems.

Line chart of Euro area net public investment, percentage of GDP, showing a Decade of no building for the future

Why have we lived off past investments for so long and failed to make enough new ones? Funding costs are clearly not an issue, with interest rates at record lows. (The crisis-hit eurozone countries in the sovereign debt crisis were an exception, but even Spain and Italy outpaced Britain’s investment by decades.)

Lack of demand and cheap labor are the more likely culprits. Businesses that do not expect sufficient demand to absorb the increased production have no reason to invest. And when they are allowed to treat workers as cheap and disposable, they may choose that over irreversible capital investment. That’s why faster wage growth and so-called “labor shortages” (actually competition for workers) are something we must accept if we want to push businesses into productive investment.

Something similar may be true of cheap energy in Europe. The 2010s were a time of unusually cheap natural gas and therefore electricity. This may have undermined the urgency to invest in both greater renewable generation and geopolitically safe natural gas developments. Oil prices were also low for most of the decade.

But beneath these economic factors, I think our failure to invest is deeply political. Raising the investment-to-GDP ratio, whether by stimulating private or public investment, or both, means that a smaller share of GDP is left for consumption. Even if it sets up a better future, today can feel like a more miserable existence. And this is something that a generation of politicians in the rich world are afraid to inflict on their constituents.

This is true in good times, when transfer payments, tax cuts, and immediate public goods are politically more attractive than capital investment. (Something equivalent is at work in the private sector: we witness the choice of companies to return money to owners through share buybacks rather than invest in their own growth.) It is also true in bad times when investment is the easiest belt expense – forcing governments and companies to lay off.

European countries began to complain about how they used the “peace dividend” of 1989 to reduce defense spending. The same moment caused the West as a whole to forget the larger idea of ​​short-term sacrifice for a more prosperous future. But this is not inevitable, as exceptions such as Canada and the sustainable investments of the Nordic countries show. Both Western voters and governments have not learned the virtue of delayed gratification. They need to learn it again, and quickly.

martin.sandbu@ft.com

Letter in response to this column:

A green economy means limiting the growth of the financial sector / By Kurt Bayer, former Board Director, World Bank and European Bank for Reconstruction and Development, Vienna, Austria