Updated November 8, 201814, 2019
Introduction to the U.S. Economy: Business Investment
What is Business Investment?
Business investment is spending by private businesses and
nonprofits on long-lasting assets, also known as physical
capital, that assistsassist in the production of goods and services.
Physical capital is generally grouped into three categories:
equipment (e.g., machinery or computers), structures (e.g.,
offices or warehouses), and intellectual property (e.g.,
software development or research and development).
Through investment, businesses can build up their stock of
physical capital, which increases their capacity to produce
goods and services. For example, when a restaurant
purchases an additional grill, it increases its capacity to
prepare food at a given time. However, over time physical
capital physical capital
tends to become less productive over time due to wear and tear
tear and eventually must be replaced as it breaks down. This
This process is referred to as depreciation. For a firm to
continually increase its stock of physical capital, and
therefore its productive capacity, it must make investments
into new invest in new
physical capital faster than its current physical
capital is
depreciating. The same goes for the economy as a
whole—
for the economy’s stock of physical capital to
increase, the
investment rate must exceed the rate at which
physical physical
capital depreciates.
Drivers of Business Investment
The main determinants of business investment are broader
economic conditions, business confidence and expectations,
and long-term interest rates.
As discussed earlier, business investment can affect the
economy, but changes in the economy also affect business
investment. As shown in Figure 1, following the beginning
of the 2007-2009 recession, business investment began to
decrease sharply. As a recession occurs, businesses tend to
see a decline in demand for their products, which leads
them to reduce investment spending. Alternatively, during a
healthy economic expansion, businesses tend to see rising
demand for their products, which leads them to increase
investment in order to increase production to accommodate
the increased demand. As such, the business cycle is one of
the largest drivers of business investment. For more
information regarding the business cycle, refer to CRS In
Focus IF10411, Introduction to U.S. Economy: The
Business Cycle and Growth, by Jeffrey M. Stupak.
Figure 1. Recent Business Investment Trends
2015-20182005-2019
Economic Considerations
Business investment is of significant interest to economists
because it can affect the economy’s short-term and long-term growth of
the economylongterm growth.
In the short term, an increase in business investment
directly increases the contemporary level of gross domestic
product (GDP), because business investment is included in
GDP. Similarly, a decrease in business investment will
decrease GDP. Business investment is one of the more
volatile components of GDP and tends to fluctuate
significantly from quarter to quarter.
In the long term, business investment, specifically the size
of the capital stock, can impact the long-term growth of the
economy. A higher stock of economy’s long-term
growth. A higher physical capital stock increases the
economy’s overall productive capacity of the economy, allowing more
goods and services to be produced with the same level of
labor and other resources. Alternatively, a lower physical
capital stock reduces the productive capacity of the
economy, all economy’s productive capacity, all
else equal. In the long term, economic growth
is generally dependent generally
depends on growth in the productive capacity
of the economy, economy’s productive capacity,
rather than swings in supply and demand.
Faster economic
growth generally translates into faster
income growth and
improved living standards. For
additional discussion of the
long-term drivers of economic
growth, refer to CRS In
Focus IF10557, Introduction to
U.S. Economy:
Productivity, by Jeffrey M. Stupak.
Source: Bureau of Economic Analysis.
Notes: The investment rate is measured as the year-over-year
change in real business investment. Grey bar indicates recession.
Business confidence and future expectations for the
economy are also expected to influence business
investment. If business owners expect rising sales and
improving economic conditions, they are more likely to
make investments intoinvest in their businesses because they
anticipate increased
demand for their goods and services.
Alternatively,
declining confidence in the economy will
likely result in
declining business investment. Business
confidence and
future expectations can be unpredictable
and difficult to influence through public policy.
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Introduction to the U.S. Economy: Business Investment
Business investment is typically financed through credit
markets. As such, interest rates influence business
influence through public policy.
Business investment is typically financed through credit
markets. As such, interest rates influence business
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Introduction to the U.S. Economy: Business Investment
investment decisions by either increasing or decreasing the
cost for a business to borrow funds, thus affecting the
profitability of making additional investments. When a firm
is evaluating a potential investment, it must determine
whether the expected benefits will outweigh the cost of the
investment. All . All
else equal, a rising interest rate will
increase the costs
associated with an investment, resulting
in fewer
investments being undertaken. Alternatively, a
falling falling
interest rate will decrease the costs associated with
investment, resulting in more business investment. This
concept is the guiding principle behind contemporary
monetary policy, with the Federal Reserve altering shortterm interest rates in order to influence long-term interest
rates in an effort to affect business investment (and interestdependent consumer spending.) The Federal Reserve is
currently on a path of increasing interest rates as it attempts
to decrease the amount of monetary stimulus in the
economy. For additional discussion of monetary policy and
the Federal Reserve, refer to CRS Report RL30354,
Monetary Policy and the Federal Reserve: Current Policy
and Conditions, by Marc Labonte.
For additional discussion of
monetary policy and the Federal Reserve, refer to CRS
Report RL30354, Monetary Policy and the Federal
Reserve: Current Policy and Conditions, by Marc Labonte.
in mid-2018. Since this peak, investment has slowed though
the rest of 2018 and 2019. The temporary acceleration in
business investment was potentially due to increased
business confidence and changes to the tax code that made
physical capital investment more attractive. For further
discussion of the effect of the 2017 tax revision, refer to
CRS Report R45736, The Economic Effects of the 2017 Tax
Revision: Preliminary Observations, by Jane G. Gravelle
and Donald J. Marples.
Saving and Investment
One of the long-term determinants of business investment is
the level of savings available to the economy. For financial
institutions to loan funds to businesses that the businesses
in turn use to make investments, other individuals must be
depositing their savings intowith those financial institutions.
Because of the global nature of the U.S. economy, firms in
the United States have access to savings from within the
United States and from abroad; thus, interest rates in the
United States are influenced by the supply of global, in
addition to national, savings. A higher supply of savings
results in lower interest rates, and a lower supply of savings
results in higher interest rates, all else equal. As such, an
increase in the supply of savings should lead to an increase
in business investment, due to declining interest rates. For
additional discussion of the supply of savings, refer to CRS
In Focus IF10963, Introduction to U.S. Economy: Personal
Saving, by Jeffrey M. Stupak
Trends in Business Investment
.
Figure 2. Historical Business Investment Trends
1948-2019
Trends in Business Investment
Foreign Investment
Business investment in the United States is made by both
domestic and foreign individuals. The United States
receives significant foreign direct investment from abroad,
amounting to about $296.4 billion in 2018, according to the
Bureau of Economic Analysis. By this measure, the largest
foreign investors in 2017 were Germany, Ireland, and
Canada. In addition to foreign direct investment,
individuals from abroad can invest in U.S. financial assets
that can provide U.S. businesses with funds to finance
physical capital investment.
As shown in Figure 1, business investment declined
sharply during the 2007-2009 recession. Deteriorating
economic conditions during the recession reduced business
revenues and confidence. The decline in business
investment persisted through the third quarter of 2009,
despite the Federal Reserve lowering its benchmark interest
rate to virtually zero beginning in late 2008. Following the
2007-2009 20072009 recession, business investment began rising
again,
with the year-over-year investment rate peaking
above 12% in around
13% in the first half of 2012. This rise in business investment
investment coincided with historically low interest rates, improving
improving business confidence, and broadly improving economic
economic conditions.
Business investment began to slow considerably by mid2014, remaining relatively flat between 2014 Q4 and 2016
Q2. This decline in investment coincided with a decline in
business confidence, as measured by the Organisation for
Economic Co-operation and Development (OECD)
business confidence index. Some commentators suggested
the decline in confidence resulted from policy uncertainty
during the run -up to the 2016 election. Beginning in mid2016, business investment began increasing again,
accelerating through 2017 and 2018. The increase in
business investment is likely due to increased business
confidence and changes to the tax code that made physical
capital investment more attractive. For further discussion of
the tax changes enacted in 2017, refer to CRS Report
R45092, The 2017 Tax Revision (P.L. 115-97): Comparison
to 2017 Tax Law, coordinated by Molly F. Sherlock and
Donald J. Marples.
peaking
In general, beginning in the late 1970s, business investment
as a percentage of GDP increased and has remained
elevated, increasing from an average of around 10.8%
between 1948 and 1975 to around 13.0% between 1976 and
20182019. As shown in Figure 2, after falling to about 11.3% by
the end of 2009, business investment, as a percentage of
GDP, has risen back to pre-recession levels of around
13.7% as of mid-2018.
Figure 2. Historical Business Investment Trends
1948-20184% as of mid-2019.
Source: Bureau of Economic Analysis.
Notes: Grey bars indicate recessions.
Foreign Investment
Business investment in the United States is made by both
domestic and foreign individuals. The United States
receives significant foreign direct investment from abroad,
amounting to about $259.6 billion in 2017, according to the
Bureau of Economic Analysis. By this measure, the largest
foreign investors in 2017 were Canada, the United
Kingdom, and Japan. In addition to foreign direct
investment, individuals from abroad can invest in U.S.
financial assets that can provide U.S. businesses with funds
to finance physical capital investment.
Foreign investment in the United States has been trending
downward over the past several years, declining from its
post-recessionpostrecession peak of about $439.5 billion in 2015.
However, the United States is not alone in experiencing a
decline in foreign investment. According to the OECD,
global foreign investment declined about 1820% in 2017.the first
half of 2019
Jeffrey M. Stupak, Analyst in Macroeconomic Policy
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IF11020
Introduction to the U.S. Economy: Business Investment
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