Analyzing the Relationship Between Investment Incentives and Business Investment Trends
Throughout this period, net investment has remained positive, helping to maintain the stock of productive capital, even during the deepest phases of the crisis. The pertinent question arises: why have companies as a whole not expanded their capacity during the past year, despite economic activity surpassing pre-pandemic levels? Various factors may explain this phenomenon; this post examines whether economic incentives for investment can elucidate the evolution of business investment in fixed capital.
The incentive to invest in a quarter is measured by the ratio between the profitability of operating assets and the financial opportunity cost of capital, with values from the previous quarter for both numerator and denominator. The variable to be explained is the gross fixed capital formation rate (gross investment per euro of operating assets). The correlation between these two variables is depicted in Figure 2. As expected, the correlation is positive and statistically significant, although the graph displays three outliers deviating from the general trend. The blue-marked point corresponds to the first quarter of 2021, when the pandemic significantly impacts the economy and drags profitability to its lowest levels; the investment rate remains above expectations due to inertia. The two yellow-marked points represent the investment rates for the second and third quarters of 2023. During this year, business activity rebounds to pre-pandemic levels, and capital profitability exceeds financial costs. Consequently, one would anticipate a recovery in capital investment, which, according to the data, does not materialize.
Based on these data, the evolution of investment incentives explains the investment trend for much of 2021 and 2022, albeit not the delay in its recovery during 2023. In this regard, it is worth considering that uncertainties about the duration of the inflationary episode and the tightening of monetary policy in 2023, along with additional geopolitical conflicts, may have represented an additional risk premium for investors and companies, thereby reducing the incentive to invest below the estimates depicted in the graph. Another factor potentially influencing the delay in investment recovery in 2023 could be related to the timelines for implementing investment programs funded by NGEU funds. In any case, if fourth-quarter 2023 data confirm the recovery of investment incentives, 2024 should witness the resurgence of capital investment by companies in Spain.