Connecting profits and investment

Paul Krugman's column on the apparent disconnect between high profits and low investment (as ever, the indispensable Mark Thoma provides the reference) has a bit of déjà vu for Canadian readers: haven't we seen this before?

But more fundamentally, I don't see why we should expect that there should be a stable relationship between current profits and current investment. The current situation in the US is worrisome, but I don't think it qualifies as a puzzle.

I'm going to shamelessly steal Menzie Chinn's wonderful technique of graphing the movements of macro variables during the last three expansions: all variables are in logs, and scaled so that their values at the NBER reference cycle troughs are equal to zero. First up is US real investment expenditures on equipment and software (a reproduction of one of Menzie Chinn's graphs):

Clearly, US investment is lagging  behind the paths of previous expansions. Let's look at 'real' after-tax corporate profits: nominal profits scaled by the GDP deflator:

So there's the 'disconnect': profits have grown much more rapidly than in the two previous expansions, but investment has grown more slowly.

As I said, this looks familiar. Here are real expenditures on machinery and equipment in Canada:

And here are  'real' after-tax corporate profits:

Investment growth was anemic during the last expansion, even though corporate profits were growing rapidly - although pretty much all of this growth amounted to  recovering from the severe drop during the 1990-1 recession. But this time around,  investment  growth is tracking the 80's expansion pretty closely, even though corporate profits are growing are a fairly moderate pace.

On to the puzzle. We'd expect current investment to be a function of the expected stream of profits that a capital good can generate during its economic life. And current profits are a function of (among other things) the level of the capital stock - i.e., accumulated past investment. Today's high profits (high in the US, low in Canada) may simply be the result of the levels of investment (high in the US, low in Canada) accumulated during the last expansion.

The worrisome bit is that not many people think that there are investment projects in the US that would justify sacrificing current consumption in order to obtain the  future income they'd generate.