The Problem of Business Investment

John Fraser, Secretary to the Treasury spoke about Australia’s Business Investment Challenge in his Sir Leslie Melville Lecture.

The bottom line is as the mining investment boom ended, Australia has struggled with weak investment in the non-mining sectors, weighing on the labour market, productivity and ultimately economic growth.

Governments to pursue coordinated reforms that provide businesses with certainty, promote innovation and productivity improvements and support the ongoing transformation of the economy.

But there are no silver bullets!

One thing we know will be vital to our economic prosperity going forward is business investment.

Investment in new productive capacity creates employment opportunities, raises future incomes and supports innovation.

Recent Treasury research indicates that Australia has generally been more reliant on capital deepening than multifactor productivity growth to fuel its aggregate labour productivity growth.

This research is publicly available on the Treasury Research Institute website.

We are doing far more research in Treasury but some necessarily must remain confidential.

Productivity-enhancing policies are vital because of the link between productivity gains and real wage increases.

We know that higher productivity is the best way to increase real wages across the economy and, based on Treasury’s recent analysis of longitudinal business data, it is clear that average real wages are higher for businesses with higher labour productivity.

Both capital deepening and multifactor productivity will be important to support further growth in labour productivity – so business investment is critical to our economic prosperity.

Recent trends

Over the past decade, Australia’s experience with business investment has played out in two starkly different stages.

Chart 1 – This chart shows the unprecedented investment boom to build new supply capacity in the mining sector in response to strong demand for resources and higher commodity prices.

Chart 1: Business investment

Such was the strength of the mining boom that total business investment increased as a per cent of GDP noticeably over this period.

This was one important factor in our economy’s resilience through the GFC, supporting jobs in a whole range of industries and seeing benefits flow on to wages and capital returns throughout the economy.

Of course, it is hard to know precisely why our economy fared so well during the GFC.

The flexibility of the economy, prudent monetary policy and a sound financial system – as well as demand from China – all played their part but it is difficult to single out any individual factor.

While mining investment declined for a time during the GFC, the demand for our resources was such that mining investment increased through to its peak in 2012-13, helping to counteract the global tide of recession through that period.

Since then, mining investment has rapidly receded.

Crucially, business investment outside of the mining sector did not take up the slack as the trend in mining investment reversed.

The share of non-mining business investment as a per cent of GDP began to fall following the GFC, and in recent years has fallen to around its lowest share of GDP in the past 50 years.

In 2016‑17, non-mining business investment was around 9 per cent of GDP.

As is clear from the chart, this is between 2 and 2 ½ percentage points of GDP below the long run average prior to the GFC – so there remains a gap that we would hope non-mining investment could fill.

In an environment of low interest rates and generally positive economic developments the extent of the weakness in non-mining investment was somewhat perplexing.

Australia has not been alone in facing this challenge.

In meetings with my counterparts from the New Zealand, Canada, UK and Ireland Treasuries over recent years weak business investment has been one of the key concerns discussed.

Author: Martin North

Martin North is the Principal of Digital Finance Analytics

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