Signs of Fundamental Economic Weakness

Just about everyone these days wrings his or her hands over the state of the economy.  Some concerns are bogus, some legitimate.  One of fundamental importance has received less notice in the media than it deserves: American business and industry have neglected their productive facilities.  Their relative paucity of spending on new buildings, equipment, and intellectual capital threatens future advances in productivity and so also prospects for long-term economic growth.

The data are striking.  This recovery has seen much slower growth in business spending than is normal.  Over the last 18 months, such spending has hardly expanded at all in real terms.  It has actually begun to decline of late, an unusual event except in recessions.  The greatest weakness has appeared in new construction.  In real, inflation-adjusted terms it has fallen during this time at better than a 3.1 percent annual rate.  Spending on new, updated equipment has declined at a more modest pace but declined nonetheless, while outlays for what the Commerce Department calls intellectual property — programming, software, new systems, and the like — has expanded at less than a 4.0 percent annualized rate, far slower than historically and even than earlier in this historically slow recovery.

What may be more telling and more ominous, rates of spending barely exceed rates of depreciation and obsolescence.  Such neglect of the need to replace what is lost typically occurs in recessions and early in recoveries, when money is short and there is a surplus of unused capacity.  But business and industry usually catch up later in the recovery.  This recovery has failed to see such a catch-up.  Presently, some six years after the cyclical turn, spending barely exceeds depreciation and obsolescence by 20 percent, far less than in comparable points in past cycles.  Indeed, net of depreciation and obsolescence, capital spending has yet to recover its nominal 2007 levels much less its real levels.  Since this situation has denied workers at all levels much more technology, equipment, and other facilities than they had almost a decade ago, it is little wonder that output per hour has grown so slowly during this recovery and has actually declined during the past 6-8 months.

This atypical reluctance by business to spend on its own productive power would seem to have grown from two roots, neither of which promise improvement any time soon.   On one level is the lingering effect of the 2008-09 great recession.  That horrible experience caught some many firms so short it should hardly surprise that managements now harbor a reluctance to spend on anything.  No doubt time and distance from those frightening events will turn decision makers away from their wariness and allow them to recapture what the great economist John Maynard Keynes called their “animal spirits.  So far, however, little sign of such an improvement has emerged or any reason to expect a change any time soon.

The other problem lies in Washington.  Policy there has sought to alter the business climate radically, not only in this administration’s aggressive regulatory posture but also in the passage of large and intrusive pieces of legislation, the Affordable Care Act and the Dodd-Frank financial reform act prominent among them.  Good or bad as policy, these measures have raised the cost of doing business and worse introduced a great deal of uncertainly into decision making.  Both have discouraged business spending.  And since much in this legislation, as well as the course of future rule making, remains unclear, there is little reason to expect business to shed its uncertainties and begin to spend aggressively.

Even if a new president and new congress were to set out next year to alter this situation, it would take a long time to have effect on current rates of capital investment, much less on the long-term outlook.  If, then, decision makers in business and industry have held back in response to their wariness over future prospects, there reluctance to upgrade and expand may well have made their pessimistic forecast a reality.

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