The Life Cycle Origins of the Investment Puzzle

Abstract

Weak US investment after the 1980s is puzzling because rising profitability and falling interest rates should have stimulated investment. I find the decline in the startup rate of new businesses is behind this missing investment puzzle. Confidential US Census micro data shows a striking divergence between micro and macro trends. Investment increased for the average firm despite a decline in aggregate investment, but changes in the firm age distribution masked this investment boom from aggregate data. Fewer startups being born aged firms and depressed aggregate investment because older firms, despite likely being more profitable, invest less intensely. In a calibrated firm dynamics model, firm aging due to falling startup rates explains 80% of the investment trend decline from 11.5% to 9% of GDP between 1980 and 2010. Given historical changes in startup rates, the life cycle model rationalizes the boom and bust in aggregate investment and its puzzling relation with profits and interest rates since the 1950s. Consistent with the model, cross-country data shows rising investment and falling profits amidst a resurgence in startup activity since 2010.