A Threat to Growth, Now and Over the Long Haul

Capital spending continues to weaken.  All indicators, whatever the source, show that business and industry remain reluctant to spend on new structures, new equipment, even new systems and computing power.  Some of the weakness reflects the falling price of oil and the cutbacks it has prompted in the energy sector.  But the problem is more general than this and is more serious.  Business, it seems, has so lost confidence that it cannot bring itself expand aggressively, a pattern that should keep growth slow for the time being but, more dangerously, will undermine the economy’s underlying productive potential and so prospects for longer-run growth as well as any meaningful increases in productivity.

Recent figures are downright depressing.  According to the Commerce Department, purchases by business of all kinds of fixed investment have fallen some 1.3 percent in real terms during the last four quarters.  To be sure, cutbacks in the oil patch have factored into this poor performance.  Spending for mining exploration, shafts, and wells has dropped about 50 percent during the past year.  But these cutbacks in energy hardly account for all or even most of overall shortfall.  Spending by all business for equipment has dropped 1.6 percent during the past year.  Perhaps more telling, spending for information processing equipment, which includes computers, tablets, and smartphones, though it continued to expand some 4.5 percent during the past year, has slowed noticeably from the 6.4 percent annual rate of advance averaged earlier in the century before the great recession.  Even spending on software, research, and development, what the Commerce Department calls “intellectual property products,” has barely maintained the 3.5 percent annual real rate of advance it showed previously.

Nor do contracts for new purchases offer much hope for a pick up in the near future.  Orders for new capital goods fell 12.3 percent between May and June, the most recent month for which data are available.  They have declined on balance 11.3 percent during the three months through June and are off 3.4 percent over the past year.  Removing the volatile defense and aircraft components from the total hardly brightens the picture.  New orders adjusted in this way have remained essentially flat over the three months through June and are down 3.8 percent over the past year.

Even earlier in this recovery, the figures, though better than recently, were far from robust.  Probably the most revealing way to look at these data is to gauge how much actual spending exceeds the amount lost to deprecation and obsolescence.  Typically business in recession cuts back on spending so that it barely replaces what has depreciated and become obsolete.  Commonly, almost immediately as recoveries improve profits and revenues, business tries to make good in the recession-enforced shortfall.  As recoveries proceed, business tends to build on these gains.  The present recovery has proceeded along these lines but in a severely muted way.  By this stage in past recoveries, new spending has exceeded depreciation and obsolescence by some 40-50 percent on average.  During the last year, business spent barely 30 percent above what it depreciated or lost to obsolescence.  Accordingly, the Federal Reserve (Fed) reports, the country’s industrial capacity has grown a mere 1.0 percent during this time.

The only explanation for this behavior is a lack of confidence.  Certainly, financing cannot be a problem.  The Fed has kept interest rates and so financing costs at record lows.  Even lesser credits can borrow at unprecedentedly low rates.  Quality credits can borrow long term at yields little different from the ongoing rate of inflation, making the real cost of financing essentially zero.  Corporations also have ample amounts of cash on their balance sheets.  These, too, could easily finance new capital spending, but management nonetheless leaves these monies idle in low-paying money market accounts and certificates of deposit.  At last measure, the Fed reports that some $1.5 trillion lies idle in this way on non-financial business balance sheets.

But cheap financing can induce little real investment spending when business leaders lack confidence that future prospects will pay.  Two factors likely explain today’s doubts.  One is the pain of the great recession.  Some companies in 2009 came too close to bankruptcy to shrug off the experience easily.  Anecdotal evidence suggests that many managements had trouble making payroll during that time.  Many also were denied funds when they went to the bank to draw on what they thought was a secure credit line.  Having suffered such experiences, it is little wonder that managements hold larger cash reserves than they once did and remain reluctant to commit funds to plans that may disappoint, as so many did during the 2008-09 downturn.  A second factor is Washington.  The last eight-some years have seen a flood of new, ambitious legislation and a plethora of new, aggressive regulations.  Without judging the wisdom of these moves, none can deny that they have engendered an atmosphere of uncertainty that also prompts business to keep more cash on hand and hesitate to expand aggressively.

The remedy to the present paucity of capital spending, then, would seem to lie in two areas.  One is a change in Washington.  This could present an opportunity to the next administration.  Even if it were to leave in place all that has transpired during the last eight years, a halt in new actions of this sort would give the business community time to weigh the implications of all that has already transpired, produce in this way greater certainty, and so form a basis for a more aggressive attitude toward expansion.  The second remedy is time.  Only distance from the terrors of the great recession can relieve the fears it engendered and allow business people to look to the future with less fear and more optimism, enough to spend in anticipation of growth.  In the meantime, prospects look mediocre at best.

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