In the first quarter of 2019, new private business investment fell to its lowest share of GDP this century — the Reserve Bank of Australia (RBA) measure which excludes net purchases of second-hand assets. That’s a potentially troubling statistic, given investment plays a critical role in the economy. In the short term, swings in capital expenditure (capex) help drive the swings of the business cycle. More importantly, by adding to the economy’s capital stock, investment helps determine the future trajectory of productivity and therefore of long-term growth, including by embodying new technologies.
So why is Australia’s business investment rate so low? Total investment comprises investment in fixed assets, changes in inventories (stocks of raw materials, work-in-progress and goods for sale) and acquisitions less disposals of valuables (items such as precious metals or stones, held mainly as a store of value). The key investment concept is captured by what the Australian Bureau of Statistics (ABS) calls “gross fixed capital formation” — “gross” because it excludes depreciation, “fixed” because it excludes stocks and “capital formation” because it only covers the physical and intangible assets (such as intellectual property) used in production and excludes financial assets.
In 2017–18, gross fixed capital formation, or investment, was equivalent to about 24 per cent of Australian GDP, down from more than 28 per cent of GDP in the first quarter of 2012. Over the same period, private business investment (RBA measure), which currently accounts for around half of total investment, has fallen from more than 18 per cent of GDP to its low of less than 12 per cent of GDP.
The mining investment boom and its aftermath explain much of the story, with the huge upswing in the commodity cycle that took place earlier this century seeing mining investment surge from less than two per cent of GDP in 2001–02 to a record high of almost nine per cent by 2012–13. Subsequently, it has fallen back to just three per cent of GDP as of 2017–18, as the big construction projects have drawn to a close. This six-percentage point decline in investment — “the investment cliff” — explains much of the overall trend in business investment.
As the decline in mining capex ends, mining investment should transition from an economic headwind to an economic tailwind.
The good news is, we’ve now made our way to the bottom of the cliff. And as the decline in mining capex ends, mining investment should transition from an economic headwind to an economic tailwind. That positive outlook is confirmed by the latest (second) ABS survey of investment intentions, which show expectations for mining investment in 2019–20 about 20 per cent higher than the corresponding estimate for 2018–19.
Looking ahead, the share of mining investment in GDP may also turn out to be permanently higher than pre-boom, since the higher stock of capital it created will require a higher rate of maintenance and replacement capex. The RBA estimates that the post-boom mining investment share of GDP is likely to be between 2.5 and 4.5 per cent of GDP, up from less than two per cent pre-boom (see graph 1 above).
The mining boom also squeezed non-mining private businesses investment, which fell from a bit more than 12 per cent of GDP in 2005–06 to about eight per cent of GDP by 2012–13. And non-mining capex has been quite slow to recover, only rising to 8.8 per cent of GDP by 2017–18 (see graph below).
That lethargic recovery partly reflects a long-running trend decline in the non-mining investment share, driven by a shift in Australia’s industrial structure away from the relatively capital-intensive manufacturing and agriculture sectors towards services. But it also reflects a more recent decline in investment rates across all non-mining sub-sectors as a move in the composition of investment away from machinery and equipment towards longer-lived assets has lowered the average depreciation rate on the non-mining capital stock, requiring a lower rate of replacement investment. Lower rates of innovation and productivity growth are also likely contributory factors. The RBA estimates that structural factors may lower the long-run rate of non-mining investment by one to two percentage points of GDP.
ABS survey data again points to an increase in non-mining investment over the coming year. This relatively optimistic outlook has been tempered recently by weak business confidence readings, despite two RBA rate cuts.
Finally, there are diverging fortunes for the two remaining components of investment.
As a share of GDP, private dwelling investment increased from a low of 4.4 per cent in the second quarter of 2012 to a peak of 6.1 per cent in 2016, powered by a construction boom driven by high and rising house prices and strong population growth. It stayed around there until 2018, but the housing market correction has since seen its share slide to about 5.6 per cent of GDP as of the first quarter of 2019. Big declines in building approvals over the past year suggest it will continue to fall over the coming year.
That leaves public investment, which accounts for around a fifth of total investment and which has risen as share of GDP in recent years, climbing from less than four per cent in the second quarter of 2013 to five per cent by the March quarter of this year. Both state and Commonwealth governments are committed to delivering more infrastructure spending over the next year and beyond, and there is evidence this can help crowd in additional private capex. With borrowing costs at extremely low levels, growth and business confidence low, and the RBA calling for more public investment to support the economy, the case for a further step up in public investment currently looks quite compelling.