Falling investment as accelerator effect kicks in

Here is a fresh sign of the impact of the economic downturn. The real value of capital investment spending by businesses fell sharply in the 3rd quarter of 2008 - investment demand is now on a steep downward path as our chart illustrates.

This is evidence for what is known as the accelerator effect. The demand for capital goods such as new machinery, factories and technology is linked to the actual and expected rate of growth of final demand for a firm’s products. When market demand slows down or falls as it is across many sectors of the economy, so the amount of spare productive capacity increases and leads to a reduction in planned investment spending. Many businesses are scaling back their investment programmes or postponing capital projects because they have lowered their expectations of future demand, revenue steams and anticipated profits. Only this week we learned that an £88m investment at car maker Toyota’s Flintshire factory has been put on hold because of the economic downturn. Manufacturers, retailers and construction companies are all holding back from going ahead with projects - the lack of demand is the main factor.

Capital investment is a volatile component of aggregate demand and in total contributes around 16-18 per cent of the UK’s real national income in any given year. The drop in investment is a portent of difficult times to come and we can expect to see further cuts in capital spending (capex) as we move into 2009. The UK economy will suffer a deep recession next year and the availability of finance to fund capital spending is severely curtailed by the ongoing credit crunch

The result will be a reduction in demand for capital goods and related inputs - bad news for those industries whose own fortunes depend on a steady flow of capital projects from the business sector.

Can government investment spending help to fill some of an increasing void?

BBC: UK businesses cut back investment