Some might think it premature to say this but we’ll say it anyway. The worst of the Covid pandemic is over. Yes, there will be occasional new waves of infections and there will even be episodic scares about new variants.
But the number of fatalities, the strain on medical systems and the damage done to economic activity from each new wave will diminish over time as doctors, policymakers, businesses and ordinary folks find ways to adjust to this dastardly virus.
Sadly, there will be a bifurcated world: the developed economies such as the US, Europe and Japan as well as China, the other East Asian economies, Australia, New Zealand and a few places like the United Arab Emirates and Singapore will do fairly well. The others may take longer to establish the vaccination programmes and improved public health procedures that will finally contain the pandemic.
As this scenario unfolds, we suspect that the recovered parts of the global economy will see a vigorous new capital spending cycle that will help to raise economic growth worldwide. As we explain below, the driving forces for this investment surge are falling into place and so are the enabling factors such as how this spending cycle will be financed.
The driving forces for a capital spending surge.
The data on capital spending is showing only some tentative evidence of strong upside. In the US, core capital goods orders, which have been a good lead indicator for business investment, have been picking up momentum in recent months and have now exceeded their 2-year ago level, putting the pandemic behind them. The Federal Reserve Bank’s survey of economic conditions called the Beige Book also found that manufacturers were turning increasingly to automation. Reports in the past few months that large corporations were planning mindboggling sums of money on massive capacity investments added to positive expectations — Intel, TSMC and Samsung have committed themselves to tens of billions of dollars of investment spending each with some of it already being implemented such as TSMC’s new US$12 billion ($15.9 billion) plant in Arizona.
There are several driving forces that could spark off a global capex renaissance.
The release of pent-up demand.
Remember that companies have endured a long period of immense uncertainty during which they deferred capacity expansions which are now catching up on them. They have had to deal with the global financial crisis in 2008–2009, then successive debt crises in the Eurozone, taper tantrums and their after-shocks in 2013–2015, the trade and technology wars as US-China frictions grew after 2017 and then the devastating pandemic. The investment drought that resulted left a tremendous amount of pent-up investment demand that could be released in the coming year or so as the world economy stabilises. If anyone doubts that capital spending is at a low base, just look at this data point — even with the robust showing so far this year, US core capital goods orders are barely above the levels previously seen in 2008. Domestic capital goods orders in the Eurozone and Japanese core machinery goods orders have performed even worse, reflecting their slower recoveries.
New investment to accommodate shifts in patterns of commerce and work.
Pent-up demand is simply to catch up on past under-investment. But in addition to that, technology spending is ramping up fast, reflecting increased outlays on the IT equipment, software and cloud infrastructure that is needed for e-commerce, enterprise digital transformation and remote working. That in turn stimulates demand for the electronics components especially semiconductors that power these IT equipment. Hence the boom in capital outlays by tech firms in the US, Europe and East Asia.
Beyond these new demands, multiple new technologies are taking off - companies have little choice but to invest in them or be superseded by rivals.
Rapid progress in improving computing power and communications speed and in combining these two advances together is creating a new industrial revolution. Marquee high-performance computing applications such as artificial intelligence (AI) and machine learning (ML) will increasingly determine competitive advantage. Those companies that fail to keep up with Industry 4.0 and related advances could disappear.
But information technology is not the only area where dramatic changes are afoot. Multiple other technological revolutions are underway in many other areas – renewable energy, bio-medical advances, new materials and advanced manufacturing processes, to name a few. These create immense new business opportunities which alone will usher in large increases in capital spending.
An infrastructure surge
President Biden is not a man to do things in half measures. After his US$1.9 trillion American Recovery Plan was passed, he is pressing Congress to approve a US$2.3 trillion programme to rebuild America’s decrepit physical infrastructure. Even if this is cut down to US$1.5 trillion, it will still be a massive boost to investment. Similarly, the European Union’s Next Generation Fund of EUR750 billion ($1.2 trillion) has been approved and will result in a spike in infrastructure investment.
Many parts of Asia including countries that have lagged behind in infrastructure such as India, Indonesia, the Philippines infrastructure programmes have been delayed by the pandemic and will be re-started. The infrastructure craze goes beyond Asia - last month, Brazil’s infrastructure minister proclaimed a forthcoming boom in the development of Brazil’s highways, railways and airports fuelled by US$50 billion in investment in concession projects by the end of 2022. He vowed that “Brazil will become an immense construction site …” We expect China to re-fashion its Belt & Road Initiative to support such infrastructure ambitions. And it is clear that geopolitical competition is encouraging the US and Japan to try to match China in regions of strategic interest to them.
A huge push to de-carbonise the world economy is just beginning, which will require massive investments.
Sizeable investment needs will be needed to retrofit existing energy infrastructure and subsidising alternative energy sources and research and development. China’s leadership is committed to reducing its carbon footprint. The Energy Transitions Committee in China estimates that, in order to achieve the net-zero carbon target date, China would need an additional US$1.6 trillion a year in 2020–2050. Similarly, the International Energy Agency estimates that developed economies will have to spend an incremental US$1.8 trillion a year in the next decade. That is why President Biden’s big spending plans include large amounts to accommodate climate change. The European Union’s Next Generation Fund of EUR750bn also has a large green component to it.
A sizeable upturn in housing investment is also likely.
Demand for new homes is being spurred by a number of factors. Global interest rates have fallen to near record-lows even as people find that working from home requires more space and in areas further from city centres than they currently are. At the same time, vacancy rates are at exceptional levels - in the US, the homeowner vacancy rate which measures the proportion of homes that are not currently occupied full-time fell to 0.9% in January, the lowest level since data was first collected in 1956. The ensuing boom in residential investment will add further legs to the global capex upturn that is underway, given its substantial share (19%) in overall fixed investment.
There is another reason to expect a revival in housing construction. More and more young people are growing resentful that they are excluded from homeownership because of rapid price appreciation – certainly in developed economies but also in the more successful newly advanced economies such as China, Hong Kong and South Korea. Affordable housing is going to become a big political issue which governments will have to respond to. This will mean tearing up outdated zoning laws and providing more fiscal incentives for new home construction.
A decisive regime shift in the policy arena will support this investment boom
There are four big regime shifts that will help create an enabling environment for the capital spending boom we foresee. These shifts will result in greater funding for investment and reduce the risks of investment for companies, especially smaller ones and enhanced potential returns.
Geo-strategic competition: It may not be a new Cold War as some call it but there is no doubt at all that the US and its allies are now galvanised to compete against China in a forceful way. The US Senate overwhelmingly passed legislation this week to strengthen the US in its escalating competition with China. The law would set aside US$250 billion to bolster the American response to China’s rise — including more spending on research and development. The US, Japan and Europe are also likely to step up defence spending for the same reason.
Fiscal support: The political economy around deficits has changed, fiscal hawkishness is off the agenda and there is a greater willingness to tolerate higher public debt. Policymakers do not want to make the mistake made in the last decade when they underestimated spare capacity and labour market slack and prematurely withdrew fiscal support for the economy. This new thinking is found in Europe as well where even once-hawkish Germany is prepared to step up spending. Companies will realise that the risk of a sudden slowdown in demand that would undermine the profitability of new capacity is thus lower and be more willing to invest.
Monetary policy: Central banks in major economies have made it clear that they will not let worries about inflation push them into an early reversal of ultra-loose monetary conditions In the US, some officials in the Federal Reserve Bank even feel that they should keep demand conditions extra-strong to achieve socio-economic goals such as driving up wage growth for the most disadvantaged segments of the population. As with fiscal policy above, these radical departures from the way monetary policy was set in the past will also reduce risks for companies that are contemplating capacity expansions.
Industrial policy: Of late, there has been a renewed willingness to use fiscal policy and other forms of government intervention to raise the supply potential of economies. This is evinced by the Biden Administration’s plans to invest heavily in education and R&D. It is also seen in the European Next Generation EU fund. In addition, there is a greater willingness to contemplate industrial policy — where in addition to the above, governments actively work to grow the economy through stepped-up R&D spending and through incentives to develop strategically important sectors.
Conclusion: Asian exporting economies would be big winners from this spending surge
As this multi-year capital spending boom unfolds, our region should benefit greatly.
Singapore, Taiwan, South Korea, and Malaysia are poised to gain substantially as these four economies are also the most heavily involved in the regional semiconductor supply chain and the manufacture of related electronic components.
India and Indonesia may gain less in terms of manufactured exports, as a result of their lack of integration with global trade which is the main channel by which spillovers from increased capital expenditure are transmitted.
However, these economies may benefit as exporters of commodities whose demand could soar when infrastructure spending steps up. Indonesia and the Philippines, for example, will benefit from greater demand for their exports of base metals such as copper and nickel.
While Hong Kong no longer has a large manufacturing sector that could gain from the spillovers from this capital spending, its specialisation in financial and professional services could see it gain from higher demand for financing the capital spending boom — as will Singapore.
Manu Bhaskaran, CEO, Centennial Asia Advisors