United States: Businesses take a (hopefully) temporary breather Global Economic Outlook, Q3 2016
What effect will the first-quarter contraction in business investment and slower employment growth have on the outlook for US economy? Going by recent trends, annual GDP growth may not slow down overall. However, unless business investment picks up, longer-term growth might be at risk.
Business investment contracted in the first quarter, and employment growth slowed over the first half. Although it is too soon to walk away from our previous outlook that 2016 will be a year of moderate growth, downside risk has definitely increased.1 This is particularly true in light of the recent Brexit vote, which may well translate into slower world growth. The fact that first-quarter GDP growth was only 1.1 percent (annualized) is not in itself a big concern. The United States has had a string of weak first quarters followed by stronger growth later in the year. For example, first-quarter 2014 GDP growth was -0.9 percent and first-quarter 2015, 0.6 percent, and each of those years achieved overall growth of 2.4 percent.2 However, the fact that a contraction in business investment played such a large role in the low topline number, and that this was the second contraction in a row, is worrisome, particularly when considered in combination with slowing employment growth.3
Figure 1 shows the contributions of the various categories of GDP to overall growth for the most recent five quarters.
- The contribution from personal consumption was almost the same in the first quarter of 2015 as in the first quarter of 2016, at 1.2 and 1.0 percentage points, respectively. In the later quarters of 2015, the contribution from personal consumption was higher on strong employment growth and some increase in real wages.
- The drag from business investment was 0.6 percentage points in the first quarter of 2016, following the 0.3-percentage-point subtraction in the fourth quarter of 2015. This is the first time that business investment has fallen for two consecutive quarters since 2009, the year the recession ended.
The United States has had a string of weak first quarters followed by stronger growth later in the year.
- Residential investment was the one bright spot in the first quarter of 2016, as its contribution rose to 0.5 percentage points from the 0.3-percentage-point contribution in each of the prior four quarters.
- Private inventory investment declined in the first quarter, as it did in the preceding three quarters.
- The contribution from exports was near zero, weighted down by a relatively high dollar and slower global growth.
- The slight positive contribution from imports in the most recent two quarters indicates falling imports, as the slowdown in business investment and change in consumers’ purchasing patterns outweighed the high dollar impact (which makes imports cheaper).
- Government spending made a positive contribution to first-quarter GDP, which was more than accounted for by state and local spending. Spending at the federal level contracted.
The decline in business investment is even more notable because it is driven by negative contributions from two of its components: structures and equipment. The third component, intellectual property (IP), made a positive contribution in the first quarter of 2016 after making no contribution in the fourth quarter of 2015. As shown in figure 2, it is not unusual for any individual component to decline in a particular quarter, but the last time that two of the components contracted in the same quarter before the two most recent quarters was in the second quarter of 2013.
Although industry details are not available for software, the major funders of R&D investment are manufacturers, who currently account for 83 percent of all business R&D spending.
Looking now at the individual components of business investment, it is clear that the investment decline in structures is concentrated in the mining sector (figure 3). Real dollar investment in mining, which includes mining exploration, shafts, and wells, has fallen 70 percent from its peak investment of $137.3 billion in the fourth quarter of 2014 to only $41 billion in the first quarter of 2016. Investment in manufacturing structures registered strong growth between mid-2014 and mid-2015 before leveling off at the same investment dollar amount as power and communication structures. Investment in commercial and health care structures has continued to rise.
Unlike the decline in structures, the slowdown in equipment investment is more widespread, but even in this category, the sharp slowdown in mining has been a contributor, although it is not possible to gauge its exact contribution. As shown in figure 4, most of the decline in equipment investment has been in transportation equipment and the “other” category. Although the data are not broken down by users of transportation equipment, it is reasonable to assume that some of the decline, particularly in heavy trucks, is tied to the oil and gas industry. Also, mining and oilfield machinery make up around 13 percent of the “other” category. However, the weakness in equipment investment that has been evident across all categories must be more widespread than can be accounted for in a sector that currently contributes only 1.4 percent of value to the economy.
Manufacturing employment has actually contracted so far in 2016, while the rate of employment growth slowed substantially in professional and business services, construction, and leisure and hospitality.
The two primary categories of IP investment are shown in figure 5. The other, much smaller category of investment in entertainment, literary, and artistic originals, with current real annual investment of around $80 billion, is not shown. With both investment in software (own account, custom, and prepackaged) and research and development (R&D), the decline in mining activity has probably played a minor role in the change in trend. In both of these IP categories, investment sentiment seems to have shifted in the second quarter of 2015—a year after the price of oil began its steep slide. Software investment picked up in the first quarter, even as investment in R&D has remained flat. Although industry details are not available for software, the major funders of R&D investment are manufacturers, who currently account for 83 percent of all business R&D spending. The largest sectors include pharmaceutical and medicine manufacturers, electronic and electronic component manufacturers (including semiconductors), and motor vehicle and parts manufacturers.
Concurrent with the decline in business investment, there has been a slowdown in employment growth. During the first five months of 2016, total nonfarm employment increased by only 150,000 jobs per month on average. The comparable number for 2015 was 229,000 jobs per month. Should this slowdown persist, the United States would see job growth of only 1.8 million this year—a substantially lower increase than the 2.7 million jobs created in 2015. Although unemployment is at a very low 4.7 percent, labor force participation (people working or looking for work as a percentage of the population) and wage growth are also low, making it unlikely that the job growth rate is slowing because of lack of potential employees.4
Since peaking in September 2014, mining employment has fallen by almost 25 percent, and figure 6 shows that the pace of decline has not begun to decrease. However, this is not the only sector where employment conditions have deteriorated. Manufacturing employment has actually contracted so far in 2016, while the rate of employment growth slowed substantially in professional and business services, construction, and leisure and hospitality.
Most of the currently available economic data are pointing to a substantially stronger second-quarter GDP growth rate, so the low employment increases seen so far in 2016 might just be a temporary pause. However, unless business investment, particularly in equipment and IP, picks up, longer-term growth might be at risk. These are the investments that create and incorporate innovation into production processes, which in turn drive productivity increases, and productivity growth has been sadly disappointing so far in this recovery.