Section 3: Feature article
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Recent trends in business investment
by Philip Cross 1
Business investment in structures and equipment (which excludes residential investment) fell nearly 20% in volumes during the 2008-2009 recession, and continued to weaken early in the recovery for a total loss of 24%. Since then, investment has recovered steadily, rising 14% in the last four quarters to recoup nearly half of its losses between its high in the third quarter of 2008 and its low in the fourth quarter of 2009.
The 24% drop in business investment was the largest of any sector of the economy, but comparable to its 20% losses in the previous two recessions. The fall in the volume of investment in 2008-2009 reflected similar declines in non-residential structures (-25.8%) and machinery and equipment (-21.8%) 2 , while the recovery of the latter to date has been stronger than that for structures (16.9% versus 11.5%). 3 Investment will increase further if firms follow through on their announced intention to boost nominal business investment by 7% in 2011, based on the recently released results for Private and Public Investment (PPI) in Canada. 4
The current recovery of business investment has been faster than recent recoveries. As noted above, investment has risen 14% in the past four quarters, compared with a 10.2% gain in the first year of investment growth after the 1990-1992 recession and 4.1% in the year after the 1981-1982 recession. The recovery of business investment invariably lags the recovery of the overall economy, trailing by two quarters in both 1983 and 1992. As such, the two-quarter lag in 2009 was typical for this sector.
Given the pivotal role business investment has played in the recent recession and recovery, this article examines trends in investment spending by major industries, putting their recent cyclical behaviour in a longer-term perspective. Since investment by industry comes from the PPI, all data in this article are in current dollars, unless otherwise specified. Business sector investment in the PPI is calculated as total non-residential investment less outlays by the education, health and public administration industries.
The dominant theme of business investment over the past decade has been the shift to energy and mining, a marked contrast with the 1990s when these industries trailed overall investment growth. 5 The level of investment in energy and mining more than doubled from $40 billion in 2002 to $86.5 billion in intentions for 2011. All other business investment only rose $20 billion from $90 billion to $110 billion over the same period (Figure 1).
The share of energy and mining soared from 29.7% of total business investment in 2000 to 44.4% in 2008. While investment in energy and mining fell 23% in 2009, twice as fast as the rest of the business sector, its recovery has been faster. Energy and mining capital outlays rose 10.2% in 2010, versus 2.3% for the rest of the business sector. This shift in investment intentions continued for 2011, as an 11% gain in planned outlays by the energy sector was more than double the 4.8% increase in intentions for the non-energy business sector. This would lift the share of energy and mining in business investment to a record 44.7% (Figure 2).
Outside of the primary sector, the only notable increases in investment intentions were in manufacturing and transportation. In particular, there continues to be a marked shift of investment by industry within manufacturing, a continuation of a broader trend in manufacturing observed in the 2000s as outlined in further detail below. Investment spending across most service industries was little changed in recent years.
Energy and mining
Overall, investment intentions in the energy sector call for a 7.8% increase in 2011, which would leave spending almost $10 billion below its 2008 peak but still equal to its second highest level on record. At $71.9 billion, the energy sector by itself accounts for almost one-third of all business investment in Canada.
However, the energy sector encompasses a number of industries with different cyclical trends. The energy sector includes oil and gas – both conventional and the oilsands – as well as utilities, petroleum refining and pipelines.
Utilities are the least cyclically-sensitive industry in the energy sector. Their intent to spend $26.9 billion in 2011 would be their eleventh straight record high, mostly due to the steady expansion of electricity generation capacity. Since 2009, utilities have surpassed conventional oil and gas as the largest segment of the energy sector.
Conventional oil and gas investment showed the largest boom-bust cycle in recent years, doubling between 2002 and 2006 to a peak of $36.1 billion, falling to $20.2 billion in 2008 and remaining low at $21.4 billion in 2011. These levels of investment after 2008 are close to where they started the decade. However, services to mining, which includes the exploration and development of new sources of oil and gas (include shale gas) is projected by the industry to rise to $5.7 billion in 2011, equalling its previous record in 2008. 6
Investment in the oilsands rose dramatically in the past decade, nearly quadrupling from 2003 to a peak of $20.7 billion in 2008. It then fell by nearly half, to $10.6 billion in 2009 (still more than double their level in 2000), before a slight rebound in 2010. Firms intend to spend $14.3 billion in 2011.
Pipeline investment to carry increased volumes of oil and gas to the US rose steadily from less than $1 billion a year early in the 2000s to a peak of $5.4 billion in 2008. Since then, investment has remained high at an average of about $4 billion a year.
Outside of energy, record high commodity prices are supporting record investment. Mining firms intend to spend $11.5 billion in 2011. Mining investment languished below $3 billion early in the decade (Figure 4). It surged to $8.6 billion in 2008 as metals prices hit all-time highs, before the start of the global recession. However, the level of investment in 2009 remained the second highest ever, and investment quickly surpassed its pre-recession peak as the recovery took hold after mid-2009.
Mining investment intentions in 2011 are dominated by $8.2 billion for metal mines, $3 billion above its previous high in 2008. Gold led the way with $3.0 billion in investment in 2011, followed by copper-nickel-zinc mines with $2.2 billion. Further downstream, investment in primary metals manufacturing also planned a rise to a record $3.0 billion in 2011. 7
Manufacturing investment intentions overall showed a 15% (or $2.1 billion) gain in 2011, the largest advance since 1995. Still, manufacturing investment remains relatively weak; the $17.1 billion of intended investment in 2011 would be the lowest of any year since 1994, outside of the recession-related slump in 2009 and 2010 (Figure 5).
Starting in the early 2000s, manufacturers in Canada faced several structural challenges, including a steady rise in commodity prices, a rapid appreciation of the exchange rate and a continuing increase in global competition. In this environment, manufacturing industries generally performed in one of two ways: one group saw sales steadily decline from 2000 thru 2008, while another posted higher sales. 8 For the purposes of this article, we have labelled these two groups of industries as 'expanding' and 'contracting'.
Ten industries comprise the expanding group. These include food, petroleum refining, chemicals, non-metallic minerals, primary metals, fabricated metals, machinery, other transportation equipment (outside of autos), plastics and miscellaneous manufacturing. Most of these industries shared one of two features which encouraged their growth between 2002 and 2008: either they were resource-based (like petroleum or primary metals), or they were investment-related, which allowed them to benefit from the investment boom that higher commodity prices helped trigger. Two of the expanding industries that do not fall into one of these two groups are unique: food demand grows steadily irrespective of the business cycle (it rose even during the 2009 recession), while miscellaneous industries by definition include fast-growing nascent industries that have seen sales rise every year since 1992 except one (in 2004).
Ten industries saw sales fall steadily even before the recession. These include wood, paper, printing, furniture, beverages and tobacco 9 , autos, textiles, clothing, computers and electronic products 10 , and electrical equipment. Reasons for their structural decline range from lower prices for forestry products as US demand fell, the end of the ICT boom in 2000, increased clothing imports from developing countries, and exposure to the slumping auto industry. Many of these industries reached their zenith at the turn of the decade, including wood, paper and computers in 2000 and autos in 1999, as some of these challenges pre-date rising commodity prices and the higher exchange rate. Indeed, manufacturing in some industries has been on a downward trend for a number of years, similar to that observed in other advanced economies.
Between their peak in 2000 and 2008, sales in the contracting group fell 32.0%, or an average of 4% a year. Over the same period, sales in the expanding group rose 44.8%, or 5.6% a year. This highlights that while manufacturing is widely-regarded as contracting after 2000, this does not apply to the entire industry. In fact, the expanding portion of manufacturing now accounts for almost two-thirds of sales and investment within the sector.
Both expanding and contracting industries saw almost identical sales losses during the recession: the contracting group shrank 17.6%, while the expanding group fell 17.8% in 2009. This reflects the unprecedented synchronised nature of the recession, which affected resource and investment demand as severely as any sector. And during the recovery in 2010, the 'contracting' group rose 10.4%, slightly more than the 'expanding' group's 8.2% gain (largely reflecting the faster recovery in the auto industry than in investment demand).
There was a change in investment behaviour beginning in the 1990s that closely tracked the course of sales after 2000 and accelerated during the recent recession and recovery. Investment by the group of industries labelled 'contracting' saw investment start to level off at $10.5 billion in 1995, following a period of large investments in autos, wood and paper. After 1995, investment in the 'contracting' sector rose only 3.1% until their peak investment of $10.8 billion in 2000. Investment by this group then fell 16% between 2000 and 2007, before plunging 48.2% over the next three years. Even with a small recovery in investment intentions for 2011, investment by this group of industries remains only half of its 1994 level.
The 'expanding' group of manufacturing industries saw investment double from $5.8 billion in 1993 to $11.1 billion in 1998 (surpassing the $10.5 billion invested by the contracting sector). This tracked the growth in sales that began in the 1990s and was sustained after 2000. Investment dipped to $10 billion during the 2001 slowdown, but rose steadily over the next seven years to a record $12.4 billion in 2008. Investment by this group of industries fell only one year due to the recession, declining 23% in 2009. A brisk recovery of investment by this group in 2010 and intentions for 2011 leaves investment plans near their pre-recession level of 2008. Starting in 1998, investment by the expanding sector exceeded the contracting sector every year, with the gap between the two widening considerably during the recession. With a quick recovery in 2010 and 2011, investment in the expanding sector was $7.1 billion above that in the contracting sector, or more than all investment in the latter group.
To sum up, the sales slump during the recession itself was equally severe for both the 'expanding' and 'contracting' group of manufacturers. However, coming on the heels of nearly a decade of falling sales, this helped trigger a marked deceleration of investment in the 'contracting' group during both the recession and recovery. The weakness of investment in this group of industries explains why overall manufacturing investment slumped to historically low levels in the last three years. Without new investment, long-term growth in any industry will be affected.
Conversely, the steady growth of sales in the 'expanding' sector over the past two decades has encouraged a steady inflow of new investments. While investment fell for one year during the recession, growth quickly resumed, and intended spending of $12.1 billion for 2011 nearly equalled its pre-recession high.
Not surprisingly, these trends in investment by industry closely follow profits by industry. Profits fell steadily in the contracting sector even before the latest recession. With steady increases in expanding industries after 2003, profits in 2008 in the expanding sector were nearly tenfold those in the contracting sector ($36.9 billion versus $3.9 billion). 11
Bifurcating manufacturing into sectors based on whether sales over the past decade were expanding or contracting also provides some insights into factory employment trends over the past decade. Using the detailed industry data from the Survey of Earnings, Payrolls and Hours shows that at its peak in 2000, the 2.0 million total manufacturing jobs were about evenly-split between the sectors where sales were about to contract and where sales subsequently expanded. As with sales, there was little indication which sectors would flourish or falter in the 2000s based on their behaviour in the 1990s. Only investment trends signalled which sectors would perform better in the decade after 2000.
From 2000 to 2010, payroll employment in the contracting sector fell 40.3% (or 345,335 persons, which represents 59% of the 588,958 factory jobs lost in the past decade). 12 Nearly two-thirds (60%) of this decline occurred before the recession hit in 2008, and the remainder occurred over the last three years. Payroll employment in manufacturing industries where sales were expanding fell by 20.7% (or 243,623 people) over the past decade, accounting for 41% of all factory jobs lost in the 2000s. Most of this drop occurred after the recession starting in 2008, as payroll jobs in this sector fell only 4.4% between 2000 and 2007 (versus a 24% loss in the contracting sector).
Investment in most services industries has been little changed in recent years. The only major shift has been in transportation, where investment has more than doubled from $10.0 billion early in this decade to a record $22.1 billion for 2011. As noted earlier, some of this upturn reflects increased investment in pipelines. But most of the increase reflects a marked expansion of urban transit systems and airport terminals.
Investment in other services has been stagnant in recent years, which is reflected in the slow recovery outside of energy and mining. Retailers have spent about $8 billion in each of the last three years, while investment in wholesaling has fluctuated between $5 and $6 billion since 2006. Finance and real estate have held capital outlays over each of the last three years below the $30 billion mark they exceeded in the previous three years. Investment in other consumer and business services was little changed, outside of accommodation and food which has returned to more normal levels after a spike in 2009.
This article highlights the importance of business investment in several respects. From a macroeconomic perspective, business investment played a key role in the recent recession and recovery. But the sectoral distribution of investment also is crucial to understanding why the economy is changing. This is evident in the rapid growth of investment in energy and mining over the past decade. The more detailed analysis in this article of investment trends within manufacturing showed their pivotal role in understanding why sales expanded in some industries and contracted in others. The recent recession substantially widened the gap in investment between these two groups within the manufacturing sector.
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