Catalog

Why investment has tumbled

The impact of changes in economic structure on the investment ratio is not easy to disentangle. One way to look at the links is through changes in sector contributions to growth, and through changes in incremental capital-output ratios (ICORs). If output shares and growth are shifting toward sectors with low ICORs, this would bring the aggregate investment rate down. But this perspective implies an element of circularity as the use of ICORs assumes that changes in output cause investment, not the other way round. Nevertheless, Figure 1.4.7 shows the sector makeup of changes in growth comparing 1990-1996 to 2000-2005.

Comparing growth in the pre- and postcrisis periods, industry and services account for most of the change. Except in Korea and Thailand, agriculture and services add more to growth, buffering the overall negative impact of the crisis. In Indonesia and Malaysia, the contribution of services to growth has overtaken that of industry. The reverse is true for Korea. Services contribution registered the largest increase in the Philippines in the postrcrisis period. In Thailand, there were no shifts in the ranking of sector contributions.

It would be difficult to distill from this any general conclusions about the impact that sector shifts may have had on the investment ratio. But in a world where ICORs link changes in output to accumulation, slower growth will of itself lower the investment ratio. If industry has a higher ICOR than either agriculture or services, then growth decelerations in industry will matter most for the investment ratio. Looking at the data through this lens is certainly interesting, but still leaves the puzzle as to why growth rates have fallen overall.

Public investment

It is also useful to establish the extent to which the decline in fixed investment rates is caused by falling public sector investment. Everhart and Sumlinski (2001) have estimated public and private components of aggregate investment ratios for a number of countries. In this dataset, public investment includes not only the capital spending of central government, but also of state and local governments, as well as capital spending of public enterprises. Figure 1.4.8 shows the percentage-point changes in public sector investment ratios for Indonesia, Korea, Malaysia, Philippines, and Thailand from 1997 to 2000 (the latest available data point). Only in Thailand was there a significant drop in public investment by 2000.

National accounts data for the pre- and postcrisis periods paint a slightly different picture. In Malaysia, public sector investment rates partially compensated for the fall in private investment, but in Thailand, public investment rates also dropped, but by far less than the fall in private investment.

Constraints on private investment

Mindful of the fact that public investment was not immune to the crisis, the remainder of the discussion focuses on factors that might have constrained private sector investment. Hausmann, Pritchett, and Rodrik (2005) suggest that low levels of investment are likely the result of either financing difficulties or low expected returns. If finance is a constraint, this could be because domestic finance is hobbled by low saving or poor financial intermediation, or because international capital is wary of country risks. But if the problem is low expected returns, a much broader range of candidate explanations presents itself.

Loanable funds

While real credit contracted sharply after the crisis, there is now little evidence of credit constraints. Outside the Philippines, where savings rates have been low for decades, domestic savings rates have remained high (Figure 1.4.9) and real interest rates are low by historical standards (Figure 1.4.10). Bank balance sheets have also strengthened greatly. Capital -adequacy ratios are up, nonperforming loan ratios are down, and banks have returned to profitability. Likewise, credit risks are lower, as corporate finances are now in better shape and property and other asset prices have recovered. International investors are again snapping up local equities. In short, there is little evidence of the generalized symptoms that would normally be present if finance was a problem.

This is not to say that there are no localized constraints on credit availability, perhaps for small businesses, or that some firms are not still handicapped by high levels of debt (see, e.g., Kramer 2006 and Lim and Kim 2005). As will be explained a little later, it is also most unlikely that investment is being held back by low levels of retained earnings.

Expected returns

If financing is not a problem, it is possible that lower investment rates reflect a fall in expected returns. Expected returns will be influenced by a wide constellation of factors including productivity levels, the availability and cost of complementary factors, and competitive pressures. Investor beliefs and deeper institutional factors, while less tangible, are also likely to be important.

Capacity utilization

The dip in investment rates that came on the heels of the crisis was hardly surprising. Sagging incomes and demand left firms with large amounts of underutilized capacity, which dragged equipment investment down. Construction activity collapsed as office property vacancies swelled. But nearly 10 years after the crisis, capacity utilization and property vacancy rates have more or less returned to "normal" levels (Figures 1.4.11 and 1.4.12), though Indonesia is still lagging. In the other countries, existing capacity may be sufficient to cope with temporary surges in demand but not with sustained expansion of output over several years.

Complementary factors

Bottlenecks in the supply of complementary factors can impede private investment. A large number of studies have pointed to the difficulties created by poor infrastructure and its impact on the costs of business (ADB, JBIC, and World Bank 2005). Infrastructure gaps have possibly widened in some of the crisis countries over the past decade and have added to business costs. But this should not be pushed too far as an explanation of why private investment spending ratios have dipped. Countries with relatively good infrastructure (Korea and Malaysia) as well as those with comparatively poor infrastructure (Indonesia and the Philippines) have seen their investment rates fall. Skill shortages might be another constraint on investment, particularly in Malaysia and Thailand.

Investment diversion

Another popular explanation for the fall in investment rates is that the crisis countries are no longer as attractive as they once were as investment destinations. In particular, the emergence of the PRC, and to an extent Viet Nam, as competitive export platforms has led to a diversion of investment flows. Figure 1.4.13 shows total foreign direct investment (FDI) flows over the period 1997-2005. Although there is some decline in the share of crisis countries through to 2003, this has been subsequently reversed. It is very likely that the PRC would have emerged as a competitive export platform even if the crisis had not occurred. The PRC cannot have a comparative advantage in everything, and even in sectors where it is an efficient producer, it seems that many investors prefer to diversify geographically rather than concentrate their FDI portfolio in the PRC (Economist 2007).

Eichengreen and Tong (2005) provide compelling evidence of complementarity in "vertical" FDI in East and Southeast Asia. Mutually beneficial spillovers are observed in industries that trade intensively in intermediate goods and parts (such as electronics). But for those industries (such as consumer goods and car parts) in which other countries directly compete with the PRC, there is some evidence of competition in other markets.

Summary

Although some evidence suggests that precrisis investment rates were "too high," postcrisis investment rates (outside Korea) now appear to be "too low. "Infrastructure bottlenecks (Indonesia and Philippines) and shortages of skilled labor (Malaysia and to a lesser degree Thailand) may have held private investment in check. But it is difficult to detect persuasive evidence of credit constraints, capacity overhang, or a blanket diversion of FDI to the PRC hampering investment.

In the next section, the question is asked whether increased risks or uncertainty may have slowed growth and lowered investment rates.