Yesterday’s report on third-quarter gross domestic product included a seemingly hopeful bit of data on business investment. Unfortunately, it was probably just another head fake.
The ray of hope shown forth from a seldom remarked upon subcomponent of gross domestic product (GDP) known as gross private domestic investment: equipment. It measures the investments by businesses in new machinery, furniture, vehicles, and other longer lasting goods. It can be a leading indicator of economic conditions because businesses tend to invest more in equipment when they expect better times ahead.
In the third quarter, business investment in equipment rose at a 10.8 percent annual rate, a big improvement from the minus 0.2 percent in the second quarter. At first glance, that looks like a sign that perhaps businesses do not think the looming recession everyone is talking about will be too bad.
A deeper look, however, dispels that optimistic interpretation. In the first place, this could be a sign that businesses expect more inflation ahead. Computers become outdated, delivery trucks break down, and desks need to be replaced. Businesses expecting prices to keep rising can move up the replacement cycle, the same way consumers stock up on goods when they fear higher prices. These replacement purchases get counted as investment in equipment the same way investment that represents an expansion of business activity does.
More importantly, there is likely a tax code provision driving this. The Tax Cuts and Jobs Act of 2017 contained a provision known as “bonus depreciation.” This allowed companies to immediately expense 100 percent of the costs of equipment and various other investments made by businesses, rather than having to depreciate it over years. The catch is that this provision begins to phase out at the end of this year. Next year businesses will only be able to expense 80 percent of the cost of newly acquired property. That creates a powerful incentive for businesses to make purchases now instead of next year.
This means that rather than acting as a leading indicator, investment in equipment in the third and fourth quarter of this year could be a contrary indicator. Some of the investment that would otherwise have been made next year has been pulled forward into this year. As a result, next year’s investment is likely to be lower than it would have been. Much the third quarter investment surge came from purchase of vehicles and computers, so those may be the hardest hit next year.
This is not a small component of GDP. In the third quarter, it added a little more than half a percentage point to the topline 2.6 percent annual rate of growth. Lower investment in equipment next year could take a significant bite out of GDP, deepening the recession.
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