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November 8, 2018
Introduction to the U.S. Economy: Business Investment
What is Business Investment?
Drivers of Business Investment
Business investment is spending by private businesses and
The main determinants of business investment are broader
nonprofits on long-lasting assets, also known as physical
economic conditions, business confidence and expectations,
capital, that assists in the production of goods and services.
and long-term interest rates.
Physical capital is generally grouped into three categories:
equipment (e.g., machinery or computers), structures (e.g.,
As discussed earlier, business investment can affect the
offices or warehouses), and intellectual property (e.g.,
economy, but changes in the economy also affect business
software development or research and development).
investment. As shown in Figure 1, following the beginning
of the 2007-2009 recession, business investment began to
Through investment, businesses can build up their stock of
decrease sharply. As a recession occurs, businesses tend to
physical capital, which increases their capacity to produce
see a decline in demand for their products, which leads
goods and services. For example, when a restaurant
them to reduce investment spending. Alternatively, during a
purchases an additional grill, it increases its capacity to
healthy economic expansion, businesses tend to see rising
prepare food at a given time. However, over time physical
demand for their products, which leads them to increase
capital tends to become less productive due to wear and tear
investment in order to increase production to accommodate
and eventually must be replaced as it breaks down. This
the increased demand. As such, the business cycle is one of
process is referred to as depreciation. For a firm to
the largest drivers of business investment. For more
continually increase its stock of physical capital, and
information regarding the business cycle, refer to CRS In
therefore its productive capacity, it must make investments
Focus IF10411, Introduction to U.S. Economy: The
into new physical capital faster than its current physical
Business Cycle and Growth, by Jeffrey M. Stupak.
capital is depreciating. The same goes for the economy as a
whole—for the economy’s stock of physical capital to
Figure 1. Recent Business Investment Trends
increase, the investment rate must exceed the rate at which
2015-2018
physical capital depreciates.
Economic Considerations
Business investment is of significant interest to economists
because it can affect the short-term and long-term growth of
the economy.
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
Source: Bureau of Economic Analysis.
economy. A higher stock of physical capital increases the
Notes: The investment rate is measured as the year-over-year
overall productive capacity of the economy, allowing more
change in real business investment. Grey bar indicates recession.
goods and services to be produced with the same level of
labor and other resources. Alternatively, a lower physical
Business confidence and future expectations for the
capital stock reduces the productive capacity of the
economy are also expected to influence business
economy, all else equal. In the long term, economic growth
investment. If business owners expect rising sales and
is generally dependent on growth in the productive capacity
improving economic conditions, they are more likely to
of the economy, rather than swings in supply and demand.
make investments into their businesses because they
Faster economic growth generally translates into faster
anticipate increased demand for their goods and services.
income growth and improved living standards. For
Alternatively, declining confidence in the economy will
additional discussion of the long-term drivers of economic
likely result in declining business investment. Business
growth, refer to CRS In Focus IF10557, Introduction to
confidence and future expectations can be unpredictable
U.S. Economy: Productivity, by Jeffrey M. Stupak.
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
business confidence index. Some commentators suggested
markets. As such, interest rates influence business
the decline in confidence resulted from policy uncertainty
investment decisions by either increasing or decreasing the
during the run up to the 2016 election. Beginning in mid-
cost for a business to borrow funds, thus affecting the
2016, business investment began increasing again,
profitability of making additional investments. When a firm
accelerating through 2017 and 2018. The increase in
is evaluating a potential investment, it must determine
business investment is likely due to increased business
whether the expected benefits will outweigh the cost of the
confidence and changes to the tax code that made physical
investment. All else equal, a rising interest rate will
capital investment more attractive. For further discussion of
increase the costs associated with an investment, resulting
the tax changes enacted in 2017, refer to CRS Report
in fewer investments being undertaken. Alternatively, a
R45092, The 2017 Tax Revision (P.L. 115-97): Comparison
falling interest rate will decrease the costs associated with
to 2017 Tax Law, coordinated by Molly F. Sherlock and
investment, resulting in more business investment. This
Donald J. Marples.
concept is the guiding principle behind contemporary
monetary policy, with the Federal Reserve altering short-
In general, beginning in the late 1970s, business investment
term interest rates in order to influence long-term interest
as a percentage of GDP increased and has remained
rates in an effort to affect business investment (and interest-
elevated, increasing from an average of around 10.8%
dependent consumer spending.) The Federal Reserve is
between 1948 and 1975 to around 13.0% between 1976 and
currently on a path of increasing interest rates as it attempts
2018. As shown in Figure 2, after falling to about 11.3% by
to decrease the amount of monetary stimulus in the
the end of 2009, business investment, as a percentage of
economy. For additional discussion of monetary policy and
GDP, has risen back to pre-recession levels of around
the Federal Reserve, refer to CRS Report RL30354,
13.7% as of mid-2018.
Monetary Policy and the Federal Reserve: Current Policy
and Conditions, by Marc Labonte.
Figure 2. Historical Business Investment Trends
1948-2018
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 into 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
Source: Bureau of Economic Analysis.
additional discussion of the supply of savings, refer to CRS
Notes: Grey bars indicate recessions.
In Focus IF10963, Introduction to U.S. Economy: Personal
Saving, by Jeffrey M. Stupak
Foreign Investment
Business investment in the United States is made by both
Trends in Business Investment
domestic and foreign individuals. The United States
As shown in Figure 1, business investment declined
receives significant foreign direct investment from abroad,
sharply during the 2007-2009 recession. Deteriorating
amounting to about $259.6 billion in 2017, according to the
economic conditions during the recession reduced business
Bureau of Economic Analysis. By this measure, the largest
revenues and confidence. The decline in business
foreign investors in 2017 were Canada, the United
investment persisted through the third quarter of 2009,
Kingdom, and Japan. In addition to foreign direct
despite the Federal Reserve lowering its benchmark interest
investment, individuals from abroad can invest in U.S.
rate to virtually zero beginning in late 2008. Following the
financial assets that can provide U.S. businesses with funds
2007-2009 recession, business investment began rising
to finance physical capital investment.
again, with the year-over-year investment rate peaking
above 12% in 2012. This rise in business investment
Foreign investment in the United States has been trending
coincided with historically low interest rates, improving
downward over the past several years, declining from its
business confidence, and broadly improving economic
post-recession peak of about $439.5 billion in 2015.
conditions.
However, the United States is not alone in experiencing a
decline in foreign investment. According to the OECD,
Business investment began to slow considerably by mid-
global foreign investment declined about 18% in 2017.
2014, remaining relatively flat between 2014 Q4 and 2016
Q2. This decline in investment coincided with a decline in
Jeffrey M. Stupak, Analyst in Macroeconomic Policy
business confidence, as measured by the Organisation for
Economic Co-operation and Development (OECD)
IF11020
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Introduction to the U.S. Economy: Business Investment
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