Are G7 Countries Falling Behind in Investments?

Since the beginning of the 1990s at the latest, investment activity in the world’s largest industrialized nations – the G7 countries – has been falling. Relative to emerging economies, industrialized nations are at risk of becoming less competitive. This will also hurt the exports of G7 countries.

Falling investments in G7 countries

A look at the share of gross capital expenditures as a percentage of gross domestic product (GDP) in the seven major industrialized nations of the world shows that these countries’ investment activities have decreased in recent decades. While the share of gross capital expenditures in 1980 was still between 19 and 34 percent of GDP in individual countries, the G7 countries only achieved investment rates between 17 and a little over 23 percent in 2016 (see fig. 1).

Source: International Monetary Fund, World Economic Outlook Database, October 2017 (downloaded on October 23, 2017)

There are many reasons for this decline in investment: the still weak economic performance in many countries following the bankruptcy of Lehman Brothers, the relocation of production stages abroad, the ageing of society in many industrial nations and more.

Regardless of the causes, falling investment has a negative impact on technological progress and productivity in a country.

Less investment = Less technological progress

A common indicator for measuring productivity in a country is the “total factor productivity.” It measures the portion of economic growth that is not due to a change in the quantity or quality of the two production factors labor and capital.

The example of Germany shows: If growth in investment falls, the pace of technological progress also decreases (see fig. 2). Since the technological progress of a country is important for its international competitiveness, a decline in technological progress worsens the competitiveness of companies in a country.

Source: Bundesfinanzministerium (Table 3 and 6).

Falling investment weakens labor productivity

Another important indicator for measuring productivity is the development of labor productivity per hour worked. A look at the long-term annual rates of change in this labor productivity shows that the change in labor productivity in Germany tracks the change in investment. A decline in the growth of gross capital expenditures comes with a slowdown in productivity (see fig. 3).

Source: Destatis, page 96.

High level of investment in emerging economies

The decline in competitiveness associated with falling investment would not be problematic for developed industrialized nations if there was also less investment in the rest of the world.

In fact, however, it is precisely the emerging economies where investment activity is far above that of G7 countries.A  It is true that the share of investments as a percentage of GDP has also been falling in many emerging economies since 2010. However, gross capital expenditures as a percentage of GDP in emerging and developing Asia in 2016 was around 40 percent. This share was twice as high as in G7 countries (see fig. 4).

Source: International Monetary Fund, World Economic Outlook Database, October 2017 (downloaded on October 23, 2017).

Impact on global trade and investment flows

The emerging economies can improve their competitiveness relative to developed industrialized nations by making higher investments. This has an impact on international trade and capital flows (see fig. 5):

• The improvement in international competitiveness in emerging economies lets these countries increase their exports to the rest of the world. Industrialized countries’ share of world trade will continue to decline.
• Productivity gains in emerging economies increase the incentive for international investors to invest in these countries. Investors can therefore benefit from higher returns.
• The inflow of capital increases investment and, with it, productivity in emerging economies. By contrast, an outflow of capital is expected in industrialized countries.

The shift in world trade and global investment for the benefit of emerging economies will also lead to a redistribution of global prosperity. The highly developed industrialized nations must adapt to these developments and consider how they will deal with the pressure on their citizens’ prosperity. Otherwise, there is a risk of social and political tension.

Fig. 5: Stylized relationship between different investment activities in industrialized nations and emerging economies and global trade and capital flows.

Source: author’s own diagram