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Updated November 14, 2019
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 assist 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, physical capital
demand for their products, which leads them to increase
tends to become less productive over time due to wear and
investment in order to increase production to accommodate
tear and eventually must be replaced as it breaks down.
the increased demand. As such, the business cycle is one of
This 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 invest in new
Focus IF10411, Introduction to U.S. Economy: The
physical capital faster than its current physical capital is
Business Cycle and Growth, by Jeffrey M. Stupak.
depreciating. The same goes for the economy as a whole—
for the economy’s stock of physical capital to increase, the
Figure 1. Recent Business Investment Trends
investment rate must exceed the rate at which physical
2005-2019
capital depreciates.
Economic Considerations
Business investment is of significant interest to economists
because it can affect the economy’s short-term and long-
term 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.
Source: Bureau of Economic Analysis.
In the long term, business investment, specifically the size
Notes: The investment rate is measured as the year-over-year
of the capital stock, can impact the economy’s long-term
change in real business investment. Grey bar indicates recession.
growth. A higher physical capital stock increases the
economy’s overall productive capacity, allowing more
Business confidence and future expectations for the
goods and services to be produced with the same level of
economy are also expected to influence business
labor and other resources. Alternatively, a lower physical
investment. If business owners expect rising sales and
capital stock reduces the economy’s productive capacity, all
improving economic conditions, they are more likely to
else equal. In the long term, economic growth generally
invest in their businesses because they anticipate increased
depends on growth in the economy’s productive capacity,
demand for their goods and services. Alternatively,
rather than swings in supply and demand. Faster economic
declining confidence in the economy will likely result in
growth generally translates into faster income growth and
declining business investment. Business confidence and
improved living standards. For additional discussion of the
future expectations can be unpredictable and difficult to
long-term drivers of economic growth, refer to CRS In
influence through public policy.
Focus IF10557, Introduction to U.S. Economy:
Productivity, by Jeffrey M. Stupak.
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
in mid-2018. Since this peak, investment has slowed though
cost for a business to borrow funds, thus affecting the
the rest of 2018 and 2019. The temporary acceleration in
profitability of making additional investments. When a firm
business investment was potentially due to increased
is evaluating a potential investment, it must determine
business confidence and changes to the tax code that made
whether the expected benefits will outweigh the cost. All
physical capital investment more attractive. For further
else equal, a rising interest rate will increase the costs
discussion of the effect of the 2017 tax revision, refer to
associated with an investment, resulting in fewer
CRS Report R45736, The Economic Effects of the 2017 Tax
investments being undertaken. Alternatively, a falling
Revision: Preliminary Observations, by Jane G. Gravelle
interest rate will decrease the costs associated with
and Donald J. Marples.
investment, resulting in more business investment. This
concept is the guiding principle behind contemporary
In general, beginning in the late 1970s, business investment
monetary policy, with the Federal Reserve altering short-
as a percentage of GDP increased and has remained
term interest rates in order to influence long-term interest
elevated, increasing from an average of around 10.8%
rates in an effort to affect business investment (and interest-
between 1948 and 1975 to around 13.0% between 1976 and
dependent consumer spending.) For additional discussion of
2019. As shown in Figure 2, after falling to about 11.3% by
monetary policy and the Federal Reserve, refer to CRS
the end of 2009, business investment, as a percentage of
Report RL30354, Monetary Policy and the Federal
GDP, has risen back to pre-recession levels of around
Reserve: Current Policy and Conditions, by Marc Labonte.
13.4% as of mid-2019.
Saving and Investment
Figure 2. Historical Business Investment Trends
One of the long-term determinants of business investment is
1948-2019
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 with 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
Source: Bureau of Economic Analysis.
Saving, by Jeffrey M. Stupak.
Notes: Grey bars indicate recessions.
Trends in Business Investment
Foreign Investment
As shown in Figure 1, business investment declined
Business investment in the United States is made by both
sharply during the 2007-2009 recession. Deteriorating
domestic and foreign individuals. The United States
economic conditions during the recession reduced business
receives significant foreign direct investment from abroad,
revenues and confidence. The decline in business
amounting to about $296.4 billion in 2018, according to the
investment persisted through the third quarter of 2009,
Bureau of Economic Analysis. By this measure, the largest
despite the Federal Reserve lowering its benchmark interest
foreign investors in 2017 were Germany, Ireland, and
rate to zero beginning in late 2008. Following the 2007-
Canada. In addition to foreign direct investment,
2009 recession, business investment began rising again,
individuals from abroad can invest in U.S. financial assets
with the year-over-year investment rate peaking around
that can provide U.S. businesses with funds to finance
13% in the first half of 2012. This rise in business
physical capital investment.
investment coincided with historically low interest rates,
improving business confidence, and broadly improving
Foreign investment in the United States has been trending
economic conditions.
downward over the past several years, declining from its
postrecession peak of about $439.5 billion in 2015.
Business investment began to slow considerably by mid-
However, the United States is not alone in experiencing a
2014, remaining relatively flat between 2014 Q4 and 2016
decline in foreign investment. According to the OECD,
Q2. This decline in investment coincided with a decline in
global foreign investment declined about 20% in the first
business confidence, as measured by the Organisation for
half of 2019
Economic Co-operation and Development (OECD)
business confidence index. Some commentators suggested
Jeffrey M. Stupak, Analyst in Macroeconomic Policy
the decline in confidence resulted from policy uncertainty
during the run-up to the 2016 election. Beginning in mid-
IF11020
2016, business investment began increasing again, peaking
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Introduction to the U.S. Economy: Business Investment
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