20140219-NATIXIS-Will_the_euro_area_experience_an_investment_boom__13页_331kb

Summary of FLASH ECONOMICS: "Will the euro area experience an investment boom?"

Core Content

This FLASH ECONOMICS report examines the recent decline in business investment in the euro area and identifies the key factors influencing this trend. It challenges the traditional neoclassical model of investment, which assumes that investment is primarily driven by aggregate demand and the real user cost of capital, by highlighting the role of macroeconomic uncertainty and firms' financial conditions, particularly in peripheral economies.

Main Points

1. Role of Business Investment in the Economy

• Business investment is a crucial component of both aggregate demand and supply, playing a significant role in economic equilibrium.
• It accounts for around 50% of total investment and 8% of GDP in the euro area.
• Business investment is more volatile than GDP and has a stronger accelerator effect, meaning it rises more sharply during expansions and falls more steeply during downturns.

2. Decoupling from Fundamental Factors

• The recent decline in business investment is not fully explained by traditional factors such as aggregate demand and real user cost of capital.
• A significant investment gap has emerged over the past three years, with the euro area's business investment-to-GDP ratio dropping from nearly 8.5% in 2011:q1 to around 8% in 2013:q3.
• The average annual business investment gap since 2011 was 3.3% of GDP in Italy, 2.7% in Germany, 2.3% in the Netherlands, 1.6% in Portugal, and 0.9% in France.

3. Key Determinants of Investment Fluctuations

• Macroeconomic Uncertainty: High uncertainty leads firms to adopt "wait-and-see" strategies, delaying investment. This is particularly evident in peripheral economies.
• Firms' Financial Conditions: In peripheral countries, firms' internal financing conditions are a key factor affecting investment decisions. This is especially important in the context of high debt levels and weak financial health.
• Capacity Utilization: While low capacity utilization may suggest underutilization of capital, it does not necessarily hinder investment. Investment often leads capacity utilization over the business cycle, and firms may invest to smooth adjustment costs.

Key Findings

• The neoclassical investment model predicts that higher output should lead to higher investment, and higher real user cost of capital should reduce it.
• Uncertainty indices such as the VIX and VDAX are at low levels, yet they fail to explain the recent weakness in business investment.
• Firm-level uncertainty data (from European Commission surveys) shows that macroeconomic uncertainty has played a significant role in investment decisions, especially in Germany.
• Gross operating surplus of non-financial corporations is closely linked to investment growth, indicating that profitability is a key driver.
• Debt levels in peripheral economies (Spain, Portugal, Italy) have worsened, contributing to financial constraints and limiting investment.
• MFI lending rates and long-term bond yields have not moved in sync, suggesting that firms face different financing conditions, especially in periphery countries.
• Capacity utilization is generally below long-term averages, but this does not necessarily impede a rebound in investment, as firms may choose to invest to prepare for future demand.

Outlook and Implications

• Confidence is returning to normal levels in most euro area countries, except Italy and the Netherlands, which could support a rebound in business investment.
• Firms' internal financing conditions are expected to improve, which may help close the investment gap.
• A strengthening global recovery is anticipated to boost expectations of future production, thereby supporting a recovery in euro area business investment.
• The report suggests that the bottleneck in investment is likely to be overcome as macroeconomic uncertainty eases and financial conditions improve.

Methodology

• A neoclassical investment model is used to estimate the relationship between investment, output, and the real user cost of capital.

• The model is applied to individual euro area countries, including core (Germany, France, Netherlands) and peripheral (Italy, Spain, Portugal) economies.

• The equation used is:

  $$
  \log I _ {t} = a _ {1} \log Y _ {t} + a _ {2} \log R C C _ {t} + \varepsilon_ {t}
  $$

• The model captures 64%-94% of investment movements, with all coefficients showing the expected signs and high significance.

Conclusion

The report concludes that while the euro area's recent investment slowdown is not fully explained by traditional economic factors, it is largely due to macroeconomic uncertainty and financial constraints, particularly in peripheral economies. With confidence improving and financial conditions expected to stabilize, the euro area is poised for a recovery in business investment, especially if global economic conditions improve.