The sustained weakness in private sector investment spending outside mining since 2012 remains something of a puzzle, particularly given that the RBA has been lowering interest rates for much of the same period. The latest GDP data revealed not only a worrying contraction in the economy, but another dip in private investment spending, including by firms outside mining.
Moreover, and perhaps even worse, the latest survey of investment plans by firms shows that managers expect to slash their spending by another 15per cent in the year ahead. In other words, on this evidence, the long slide in investment spending has further to run. This is despite business confidence having recovered from the lows of the financial crisis to above long term average levels.
So what is going wrong? There is a combination of factors that convinced former RBA Governor Glenn Stevens to describe the core problem as an absence of “animal spirits”, a term first used by famous economist John Maynard Keynes back in the dismal days of the 1930s, during the Great Depression. Why are so many decision makers so risk averse?
It’s clear that many managers are anxious about offshore developments, even from afar. There is the perception of economic wobbles in China and in Europe, and now the imminent ascension to the presidency of Donald Trump and application of his suite of protectionist policies. There also now are the ever-present concerns about geopolitical troubles.
The weakness of private investment perhaps shines a light on the urgency for higher public sector spending to fill the void, but here the latest news also is bleak. The recent GDP data showed an even steeper decline in public investment last quarter than was the case for private firms.
In the latest AICD Director Sentiment Index (DSI) for the second half of 2016, directors identified global economic uncertainty as the main economic challenge facing Australian business.
The weakness of private investment perhaps shines a light on the urgency for higher public sector spending to fill the void.
Closer to home, it seems managers want to see higher profits and firmer demand before pulling the trigger on new investment. The latest news that the economy shrank certainly will not help in this regard. In fact, the “sticker shock” of a rare fall in GDP could make the risk aversion even worse.
The other explanations for the lack of investment are more esoteric. Hurdle rates of return remain unreasonably high in this so-called low return world, and some managers are incentivised to boost near term profits and pay higher dividends to shareholders at the expense of longer term investment. There also has been the application of tighter credit conditions by some financial institutions, making borrowing more difficult.
The good news is that most assets have finite lives and eventually need to be replaced, so investment cannot be delayed indefinitely. Plant and equipment reaching the end of its workable life will necessitate a lift in investment as assets are decommissioned.
There remains a strong case, however, for governments to borrow now for urgent infrastructure, particularly with interest rates so low. Much needs to be done to tidy up governance of public sector decision making around investment, like the application of standardised cost benefit analysis, but the scope for higher, well-scrutinized public investment, is significant and would be welcomed by the director community.
According to the latest DSI survey, directors continue to see infrastructure as the top priority that government should address in both the short and long term.
The Director Sentiment Index is a key indicator of the issues that are important to AICD members and the wider director community. The results of the survey for the second half of 2016 are now available.