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Australia – Business capital spending falls in March quarter, but outlook remains positive – Bill Mitchell – MMT


The Australian Bureau of Statistics has released the latest version – Australian private new capital spending and expected spending – Today (26 May 2022), this is part of several editions ahead of the release of the March quarter national accounts next Wednesday. Today’s business investment figures show that private new capital expenditure in Australia fell 0.3 per cent in the third quarter but rose 4.5 per cent year-on-year. The decline in business investment was actually modest as uncertainty persisted about the extent and duration of current supply-side disruptions. And the anticipated investment plan suggests that those in charge of capital spending still have no sense of crisis. One of the challenges for the new federal government is maintaining optimism about the economy to avoid consolidating this quarter’s decline in business investment. If the new Treasurer continues to emphasise the A$1 trillion debt and the need to cut the fiscal deficit, they will be unable to meet the challenge, businesses will be spooked and we will be heading for a recession with persistent inflationary pressures.

ABS data shows that for the March 2022 quarter (actual and seasonally adjusted):

  • Total new capital expenditure fell 0.3% in the quarter but rose 4.5% year over year.
  • Building and structural investment fell 1.7% in the quarter but rose 7.1% year over year.
  • Equipment, plant and machinery grew 1.2% in the quarter and 1.8% year over year.
  • Mining investment fell 0.3% in the quarter, but rose 2.48% year-on-year.
  • Manufacturing investment fell 1.5% in the quarter and 6.9% year-on-year.
  • Non-mining investment fell 0.3% in the quarter and was down 9.7% year-on-year.

The first graph shows the scale of Australia’s problem with investment in productive capacity. It shows total real capital formation from the September 1987 quarter (start of the sample) to the March 2022 quarter.

The giant hump is associated with a once-in-a-century mining boom (see below).

The chart below shows real private capital expenditures by broad sector.

The booms and busts of the mining industry are historically extraordinary.

The graph below shows the actual quarterly percentage change in aggregate mining private capital expenditures from the December 2007 quarter to the March 2022 quarter.

The damage to capital formation from the global financial crisis is clear.

The same was true, with some sporadic recovery in investment spending that led to the pandemic, but fortunes turned in 2020 as the fallout from the pandemic dampened sentiment.

Expected business investment

ABS—— Explanatory Notes – Help us understand their expected investment spend series.

We read:

Surveys are conducted on a quarterly basis and reported within 8 or 9 weeks of the end of the quarter to which the survey data relates (for example, March quarter survey reports are completed in April and May).

– Companies are required to provide 3 basic data in each survey:

– Actual expenditure incurred during the reference period (Act)

– Short-term expectations (E1) and long-term expectations (E2).

Regarding this model, the ABS said that for 2022-23:

  • The first estimates are available from the December 2021 survey as long-term expectations (E2)
  • The second estimate comes from the March 2022 survey (again as a long-term expectation)
  • A third estimate is available from the June 2022 survey as the sum of the two expected values ​​(E1 + E2)
  • In the September 2022, December 2022, and March 2022 surveys, the fourth, fifth, and sixth estimates came from actual expenditures (for the portion of the year completed) and projected expenditures (for the remainder of the year, respectively) ), as recorded in the quarterly survey
  • The final (or seventh) estimate for the June 2023 quarterly survey is derived from the sum of actual spending in each of the four quarters of fiscal 2022-23.

As a result, we have the graph below showing total year-to-date capital expenditures (solid bars) and expected full-year capital expenditures (transparent bars), which allows you to track changes in spending (planned) expectations and what actually happened.

It is clear that the expected (planned) private investment spending in 2022-23 is higher than this year, which is still a quarter.

ABS states:

Estimate6 for 2021-22 is $142.8b

This is 1.4% higher than the 2021-22 estimate5

The 2022-23 estimate2 is $130.5b

This is 11.8% higher than the 2022-23 estimate1

In other words, companies’ investment plans point to spending expansion over the next 12 months, suggesting that companies don’t think the inflationary period will turn into a prolonged period of stagflation, with sufficient demand within a year. Time to soak up the extra capacity.

The chart below shows the expected investment over the next 12 months (estimate 3), our latest investment for 2021-22.

After contracting 11.9% in 2021, it has gained 17.3% in the recent to current period.

Why is this important?

A fundamental insight from the economic growth literature (the Harrod-Domar approach) is that any notion of a steady state (the economy at rest) is transitory due to the dual character of investment spending.

1. Investment increases total spending current period (demand-side effects) and stimulate income growth.

2. It also increases the productive capacity of the economy (supply side effects) and increases potential future income and output.

In order to take full advantage of the growing productive capacity, the economy must also experience an adequate increase in aggregate demand to absorb the increase in output levels resulting from the increased productive capacity.

This means that the level of income that might be consistent with full employment of capital and labor in the current period will fall short over time as productive capacity grows through investment spending.

Therefore, aggregate demand must grow in the next period to ensure that the additional capital is fully utilized. The spending side of the economy can be thought of as always pursuing the capacity growth it creates.

The dual nature of investment increases the likelihood of a crisis if capital and labor resources sit idle as aggregate demand fails to keep pace with productive capacity growth.

When investment spending is sluggish, the problem is different.

Then productivity growth slows and the inflation ceiling falls.

what does this mean?

This means that potential GDP (the ability of the economy to produce output) falls at the same time as actual output, as the lack of current spending drives companies to cut back, as well as their forward-looking investment spending plans.

This means that the economy can only support lower overall GDP growth rates (and job creation) without encountering capacity constraints.

This has become a major problem for countries after a prolonged recession.

Another aspect of investment behavior that we observe in the real world is asymmetry. Investments in new equity typically require companies to make substantial and irreversible capital expenditures.

Capital is not a piece of putty that can be retrofitted into any possibly suitable configuration (i.e. different types of machines and equipment). Once a company makes a massive investment in a new technology, they stick with it for a while.

In an environment of pervasive uncertainty, companies are becoming cautious in times of pessimism and adopting wide margins of safety when deciding how much to invest.

Therefore, they form an expectation of future profitability by comparing current capacity utilization with its normal usage.

They will only invest when capacity utilization exceeds normal levels. Therefore, investment varies with capacity utilization within a certain range, so the rate of growth above and below the production capacity.

Therefore, asymmetric investment behavior can lead to asymmetry in capacity growth, because production capacity only grows when there is a shortage of capacity.

This insight has major implications for the way the economy recovers and the need for strong fiscal support in the event of a deep recession.

Two conclusions can be drawn from these observations.

1. Currency issuance Governments should avoid recessions as much as they can, as not only do they have devastating short-term effects, but they can also lead to a shortage of investment that can lead to future problems due to capacity shortages.

2. Understand that investment is asymmetric, meaning that policy should strive to instill confidence in the sales environment over several periods to encourage firms to invest in new capacity based on confidence that output that capacity can support will sell.

Evaluate

With these points in mind, it’s clear that one of the challenges for the new federal government is to maintain optimism about the economy to avoid cementing the trend of declining business investment this quarter.

If the new Treasurer continues to emphasise the A$1 trillion debt and the need to cut the fiscal deficit, they will be unable to meet the challenge, businesses will be spooked and we will be heading for a recession with persistent inflationary pressures.

Business Conditions and Sentiment Data Release – Mixed Evidence for Inflation

ABS also released their – Business Conditions and Sentiment, May 2022 – The data, which is interesting because it tells us something about the way Australian businesses view the current inflation event.

as shown by data:

1. 38% of businesses “expect prices to rise more than usual” – little change from March’s result, suggesting no acceleration in inflation expectations.

2. 48% “have no plans to raise prices of goods and services in the next three months” – a big sign that cost pressures are not widespread (mainly because wage growth remains low).

3. Among 38% of respondents, the main reasons are higher input costs (92%) and higher energy/fuel costs (78%). The two factors are not independent, as input costs are being passed on to other companies bearing rising fuel costs.

We will observe at some point that when OPEC increases supply and prices fall, because once production starts to fall, as the economy slows and demand falls, their attempt to squeeze profits backfires and those pressures go away.

4. Of the 48% of respondents, 46% said they needed to “retain customers” and 46% said “fixed price contracts.”

We’ve known for years that companies will defend market share (retain their existing customer base) rather than pursue short-term profits and find they lose their habit of other companies in the same segment.

Additionally, catalog pricing is an important aspect of any market, and companies know that if they become capricious about previously advertised prices, they will lose more sales than they earn.

Of the 48% of the population, 39% reported this as a cause.

In other words, prices are sticky for a certain period of time.

It remains to be seen whether the reasons for the “stickiness” go beyond the current temporary pressures pushing up energy and other costs.

I’m skeptical given that the pressure is mostly from pandemic-related supply disruptions.

5. In terms of different industries, the “expected price increase” in retail trade, finance and insurance, transportation, postal storage, and public utilities has eased.

This appears to be global weakness, consistent with the evidence I presented yesterday that cost pressures in Europe have declined for the second month in a row.

in conclusion

Next Wednesday, the Australian National Accounts will be released and we will see how much this negative investment performance is weighing on growth.



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