The investment drought of the last two decades is catching up with us

In all the talk of “building back better” and “match fit,” making economies “strategically autonomous” and “resilient,” there is an unspoken but tragic premise. For decades, most advanced economies have not built their futures, but suffered in an investment drought that is all the more scandalous for being unrecognized.

Between 1970 and 1989, the share of gross domestic product devoted to investments in six of the world’s seven largest economies averaged between 22.6 percent in the United States and 24.8 percent in Germany. The seventh, Japan, was an outlier at 35 percent.

Of the G7, only Canada has sustained this level of investment: its 22.5 percent this millennium is little lower than 22.8 percent then. All others managed to match 1970-89 investment levels in only four cases: the US in the boom years of 2000 and 2005-06, and France in 2021.

Yet the last 20 years have been an era of lower funding costs than ever before, first due to market exuberance, then thanks to ultra-loose central bank monetary policy. And what do we have to show for all the cheap credit? Two lost decades for investments. As business writer Annie Lowrey puts it succinctly, “We screwed it up.”

France and the US have invested almost two percentage points of GDP less this century than in the 1970s and 1980s; Germany and Italy about 4.5 points down; the UK and Japan 6 and 10 percentage points lower respectively. Those are enormous numbers. The G7 accounts for about $45 trillion in annual GDP. Restoring their investment rates could close nearly half of the global gap to the $4 trillion the International Energy Agency requires for annual clean technology investment if we are to reach net-zero by 2050.

Those are total investment numbers, but a similar story applies to the public sector alone. In the US, net government investment (after accounting for depreciation of the existing public capital stock) fell by almost two-thirds in the decade to 2014, when it fell to 0.5 percent of GDP.

Line chart of US government net investment as a percentage of gross domestic product showing underperforming reconstruction

In the eurozone, net public investment fell in the same year, thanks to extreme austerity measures in the eurozone periphery and chronic underinvestment in Germany.

Some are tempted by claims that we needn’t worry. It’s normal to invest less as you get richer – so one argument goes – because it’s increasingly futile to add to an already large capital stock. The cost of capital goods has fallen, allowing you to buy more real investments with the same money, says another. A third reason is that the current economy requires intangible rather than physical capital and while this is more difficult to measure, countries appear to be doing better on this front.

But such assurances, even if they are factually true, are useless. No one who looks closely at the physical infrastructure of most Western countries can believe that it is fit for purpose – not when that purpose extends to the decarbonization of our industries and our energy and transportation systems.

Line chart of Eurozone net public investment, percent of GDP, shows a decade of not building for the future

Why have we lived on past investments for so long and failed to make enough new ones? Funding costs were clearly not the problem as interest rates were at record lows. (Eurozone countries in the sovereign debt crisis were the exception, but even Spain and Italy have outinvested the UK for decades.)

A lack of demand and cheap labor are more likely. Companies that don’t anticipate enough demand to absorb the expanded production have no reason to invest. And if they are allowed to treat workers as cheap and available, they can choose that over irreversible capital investments. For this reason, we should embrace faster wage growth and so-called “labor shortages” (actually competition for labor) if we want to spur firms into productive investment.

The same may be true for cheap energy in Europe. The 2010s were a time of unusually cheap natural gas and therefore electricity. This may have undermined the urgency of investing in both increased renewable energy generation and geopolitically safe natural gas developments. Oil prices were also low for much of the decade.

But among those economic factors, I think our failure to invest is deeply political. Increasing the investment-to-GDP ratio, whether by boosting private or public investment, or both, means that a smaller proportion of GDP is left for consumption. While this promises a brighter future, it can feel like a measly existence today. And that’s something a generation of politicians in the rich world feared imposing on their voters.

This is true in good times, when transfer payments, tax cuts and immediate public goods are more politically attractive than investments. (Something similar is at work in the private sector: companies have chosen to return cash to owners through share buybacks rather than investing in their own growth.) This is true even in bad times, when investing is the easiest expense for Belt governments and corporations tighten the cut.

European countries must regret how they used the 1989 “peace dividend” to cut defense spending. The same moment caused the West as a whole to forget the broader idea of ​​short-term sacrifices for a more prosperous future. However, this is not inevitable, as shown by exceptions such as Canada and the sustained investments in Scandinavia. Both Western voters and governments have forgotten the virtue of deferred gratification. You must learn it again, and quickly.

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Letter in reply to this column:

A green economy means slowing down the growth of the financial sector / By Kurt Bayer, Former Executive Director, World Bank and European Bank for Reconstruction and Development, Vienna, Austria

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