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How business investment drives the economy

During the recession of 2008-2009, business investment plunged 20 per cent, matching its decline in the previous two recessions.


Philip Cross is a senior fellow at the C.D. Howe Institute and former chief economic analyst at Statistics Canada

Economists -- who can be odd people -- sometimes ask themselves which single data series they would choose to receive, if stranded on a desert island and wanted to keep track of the economy. Typical answers -- or the ones I have heard -- usually focus on commodity prices or financial markets.

My choice would be business investment. If you know what firms are planning to spend, you have a good idea where the underlying trend of the economy is going, and whether firms will be hiring, which is a good predictor of consumer spending.

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Investment drives the economy. When the investment rate (business investment as a share of the economy) rises the unemployment rate soon falls, and when the investment rate falls, unemployment invariably rises.

That is why Wednesday's release of Statistics Canada's annual survey of investment intentions is so important. Not only does it tell us how much firms intend to spend this year, but the tremendous industry detail reveals which industries are likely to be expanding or contracting over the next few years, since this is the planning horizon on which most firms operate.

Even in the investment survey, business investment is a buried nugget. First, you have to throw out CMHC's forecast of housing, which is irrelevant for tracking the business sector. Next, get rid of all the government industries of public administration, health and education. What you are left with is what we want; business investment in plant and equipment.

The results show that firms are planning to accelerate their investment plans in 2012 by 8.8 per cent. During the recession of 2008-2009, business investment plunged 20 per cent, matching its decline in the previous two recessions. Following this shock, firms were slow to start raising spending, doing so tentatively at first in 2010, and then with increasing confidence early in 2011. The results for 2012 show that the recent turmoil in financial markets, particularly in Europe, has not materially dampened business confidence in continued growth -- a confidence borne out by the recent gains in corporate profits and the stock market so far this year.

The detail by industry is as encouraging as the overall numbers. Mining grabbed the headlines with an 18 per cent gain, led by the oil sands. But growth was widespread, from wholesalers and retailers to manufacturers and transportation. This reflects the strong fundamentals of corporate finances in Canada and widespread business confidence in Canada's ability to take advantage of a strengthening global economy.

Since firms intend to boost investment in 2012, can we close the books on the year and turn our brains off? Unfortunately not, so you will have to keep reading business reports. At this time last year, firms said they were planning a 7 per cent increase, but the final gain was closer to 10 per cent. Why the difference? At the time of the survey, the beginning of the year, not all firms have finalized their investment plans. And these plans do change, according to the course of the overall economy and the individual circumstance of each firm. Still, the initial reading of business investment is a good start for the economy -- and for those looking for a job.

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