July 03, 2002

The Upward Shift in Gross Investment in America

Before the 1990s there was some evidence for a long, slowly-moving upward trend in the volume of investment relative to GDP. Many Republican politicians (and a few analysts) thought that the Reagan tax cuts of the early 1980s had generated an investment breakthrough: they looked at the rise in investment from 1982 to its 1984 peak, projected this rise forward, and forecast rapid economic growth as it was "morning in America." But whatever supply-side incentives did in the mid- and late-1980s to boost demand for investment funds, the large federal deficits (and the swing in the balance of payments back toward zero) did more to drain the pool of savings and reduce the supply of potential investment funds. Anomalously, the later 1984-1989 stage of the 1980s expansion saw not rising but falling investment relative to GDP.

The 1990s, by contrast, saw a stunning explosion of investment in America. A fall in private savings was greatly outweighed by a combination of the Clinton administration's successful commitment to deficit reduction, the return of foreigners' willingness--nay, eagerness--to invest in America, and stunning declines in the relative prices of high-tech investment goods that gave firms undertaking investment projects much more bang for the buck.

What happens next? Already, in the first quarter of 2002, price declines have kept real investment spending in the U.S. economy higher than at any point before the very end of 1998. It seems certain that when the investment-contraction portion of the recession that began in 2001 comes to a close, real investment in the American economy will still be higher at the recession trough than it was at any previous boom peak.

The Rise in Real Investment Relative to GDP

ChartObject Chart 2

From the National Income and Product Accounts prepared by the Commerce Department's Bureau of Economic Analysis. Real gross private investment divided by real gross domestic product [GDP].

Posted by DeLong at July 3, 2002 01:12 PM | TrackBack


But this is where the downside of rapid technological change kicks in. The stuff businesses were buying depreciated rapidly. So net investment wasn't going through the roof to the same degree.

Posted by: Arnold Kling on July 4, 2002 02:32 PM

True. However, the ratio of IT capital to output was growing rapidly--and if you think that one of the chief reasons capital is important for growth are that using it increases the skills and capabilities of the labor force...

It's a genuinely hard analytical problem.

Brad DeLong

Posted by: Brad DeLong on July 5, 2002 08:08 AM

Dear Brad

How much of the increase in investment is due to hedonic prices for IT capital ? How much would measured investment have increased before the 90's had hedonic price indices been used for other goods ? I sure don't know. Do you ?

Posted by: Robert Waldmann on July 5, 2002 11:04 AM

I was inclined to say relatively little--that shifting to hedonic prices would have some but small effects on the rate of growth of pre-1980 equipment investment, and next to no effect on pre-1980 structures investment. And I had done preliminary calculations that had convinced me I was probably right.

But now Karl Whelan at the Federal Reserve has written a paper saying that unmeasured equipment quality is a *big* deal for much of the twentieth century. And I haven't decided what I think of it yet.

Brad DeLong

Posted by: Brad DeLong on July 5, 2002 06:13 PM
Post a comment