Financing the capex boom
I recently argued that a ‘great reindustrialisation’ process was likely across advanced economies, after a few decades of broadly declining capital investment. There are several reasons for substantially increased capex: industrial policy and global economic fragmentation; technology and the net zero transition; as well as an aging population. This will be positive for growth, including (hopefully) productivity growth.
But there will be winners and losers in terms of who benefits from these investment dynamics. Capex is not self-financing.
There are several economic/policy factors that will shape the ability of economies to attract and mobilise the capital to finance increased productive investment: the size of the domestic market; the sectoral and firm mix; fiscal space and industrial policy; as well as national savings rates and capital market dynamism. Analysis of these factors indicates wide variation in the likely trajectory of capex across economies – and by extension, in national economic performance.
Politics also matters. From the UK to France (discussed in my last note), increased political uncertainty leads to investors demanding a higher risk premium and reducing investment. And although the US has been able to attract substantial amounts of foreign capital for decades, there are growing political and institutional risks to investor willingness to allocate capital into the US.
Countries with stronger political institutions have an edge in terms of attracting investment; there is a positive relationship across advanced economies between institutional strength and FDI inflows, as well as investment more broadly.
In addition, geopolitical rivalry will shape capital flows. As with trade flows, capital flows are increasingly shaped by geopolitical alignment – with investment flowing to more ‘friendly’ countries.
As one example, FDI and portfolio flows into China have collapsed since Covid. Part of this is due to the weaker economic outlook in China. But it is also due to heightened geopolitical risk as well as expanding Western (particularly US) government restrictions on investment into China – notably in advanced/sensitive technology. In the other direction, FDI from ‘Western-oriented’ economies into the US is increasing. Investment capital will increasingly flow within geopolitical blocs.
Overall, there will be significant variation in the extent to which advanced economies participate in reindustrialisation. Capex will be located in jurisdictions with better political/institutional foundations; those that are able to attract capital from geopolitically-aligned partners; as well as those with economic policy settings that are supportive of attracting and mobilising capital.
In contrast, those economies that struggle to attract and mobilise productive capital will not participate fully in this reindustrialisation process. These capital allocation dynamics will have first-order effects on economic behaviour and performance across advanced economies. The benefits of the great reindustrialisation will be unevenly distributed.
A version of this note with charts is available at: https://davidskilling.substack.com/p/financing-the-capex-boom