CAPITAL SPENDING SLOWS TO A CANTER
Sure was nice while it lasted.
As the American economy boomed over the last three years, so did capital expenditures. Sales of everything from computers to trucks to machine tools soared, and the U.S. enjoyed the strongest capital-spending boom since the 1960s. Now, as the economy slips into lower gear, the torrid pace of business spending is likely to cool off as well.
Capital spending took off, starting in 1992, for the usual demand-driven reasons. As economic activity increased, industrial capacity was taken up, forcing manufacturers to add equipment to boost production. Record profits--always the most powerful impetus to business spending--funded the purchases. Now, says Mark Zandi, chief economist at Regional Financial Associates Inc. in West Chester, Pa., the economic drivetrain is shifting into reverse. After growing a red-hot 5.1% at the end of 1994 and 2.7% in early 1995, the economy stopped nearly dead in the second quarter. Real gross domestic product grew just 0.5%. In the second half, Zandi expects growth to hit 1.8%, then revive next year to about 2.7%.
The result: The recent double-digit gains in real capital spending are fast disappearing. After growing 18% in 1993 and 17.6% in 1994, spending is expected to slow to around 14% this year. Next year, lagging behind the slowdown in output growth, capital goods expenditures will rise more slowly. Zandi predicts a gain of 5%. But consensus is hard to find: Though DRI/McGraw-Hill is predicting a gain of just 2.6%, optimists expect growth in the high single digits.
Clearly, the spending boom won't go completely bust. Throughout this cycle, several special factors have fueled the rise in capital spending--and those trends are not likely to end any time soon.
RICH COUNTRIES. First is the rush by corporations to substitute capital for labor--a shift that shows no signs of abating. "It's a phenomenon in all rich countries," observes Rosanne M. Cahn, chief economist of the equity department at CS First Boston Co. With interest rates, inflation, and capital goods prices low--or even declining, as with computers--the cost of capital versus labor has fallen markedly. Zandi figures that the annual aftertax cost of financing the purchase of equipment is about 4.25% today, compared with 12% in 1982. Although unit labor costs are now increasing at less than 1% annually, they've nonetheless risen 39.2% over the same period.
Also bolstering spending is the need to replace outdated capital stock, particularly computers. The information-technology revolution is rendering much equipment obsolete at a breakneck pace. In real terms, spending on computers jumped 52% in 1993 and 27% in 1994. It's slated to grow 23% this year and an additional 12% in 1996, according to DRI/0McGraw-Hill. A forthcoming government revision will reduce these numbers somewhat, but aggressive spending on computers and telecommunications equipment will continue. "The qualitative nature of this boom will not change," says Allen Sinai, chief economist at Lehman Brothers Inc.
Those factors should keep the capital-spending party from petering out altogether. After next year's slowdown, economists expect expenditures to rebound to a pace at least double that of output growth, as the economy itself picks up again. By 1997, DRI/McGraw-Hill expects spending to bounce back to 5.9%--a more than respectable showing as the expansion moves through its middle age.By Karen Pennar in New York