Recessions almost always involve the unwinding of excesses. Prior to the 2001 downturn, businesses loaded up on hot new technology, the buildings to house it, the inventories to support demand, and the employees to make it all work. Then came the bust and the pain from all that indigestion. That general scenario of overindulgence, this time in housing, is playing out again. One thing, however, has gone largely unnoticed amid the housing and credit market turmoil: In recent years nonfinancial corporations traded in their late-'90s exuberance for a new prudence that is already helping to limit the overall pain of the current economic weakness.
Start with the labor markets. Business hiring since the last recession has been the slowest of any recovery since World War II, so payrolls are already relatively lean. The unemployment rate is rising, to 5.5% in May—not so much because businesses have been aggressively laying off workers, but more because they have been reluctant to add new hires.
As a result, the rise in weekly initial claims for unemployment insurance has been moderate compared with past recessions, as has been the rate at which companies are trimming payrolls. The May decline of 49,000 jobs brings the average loss since the December peak in payrolls to 65,000 per month, half the pace over the similar period in 2001. Plus, even though productivity usually falls in a weakening economy, output per hour worked among nonfinancial corporations in the first quarter posted the largest increase in 3 1/2 years.
Like hiring, capital spending since the last recession has been cautious by historical standards. Since the end of the 2001 recession, production capacity in manufacturing has grown 0.9% per year, compared with 5.1% annually in the decade following the 1990-91 slump. That means less excess capacity, and thus less pressure to cut outlays as demand weakens. Despite the sharp slowdown in the economy, capital outlays by nonfinancial corporations through the first quarter have not collapsed as they typically have in response to a flagging economy.
Funding for operations and expansion does not appear to be a problem, despite worries over tighter credit. Cash flow currently covers only three-fourths of capital expenditures, but nonfinancial companies were still able to borrow at a good clip through the first quarter, and bond issuance rebounded strongly in April and May. April orders for capital equipment other than aircraft rose to a 1 1/2-year high and stood far above the first-quarter average. April outlays for business construction rose strongly for the third month in a row despite concerns about tighter standards on commercial mortgages.
One of the most important areas of corporate discipline has been tight inventory control. That will limit the need to slash production and put companies in a better position to respond to any firming in demand in the second half. Businesses began adjusting to last year's downswing in demand quickly, with major inventory liquidations in both the fourth and first quarters. The ratio of inflation-adjusted inventories to sales in manufacturing and trade began the second quarter far below the levels seen at the start of the past two recessions.
Finally, nonfinancial companies have maintained rock-solid finances. Their aggregate balance sheet through the first quarter shows strong cash flow and a near-record level of liquid assets, which is also high relative to short-term debt. A high percentage of overall debt is long-term at fixed rates, with extremely low and stable interest expense, and the ratio of debt to net worth is the lowest in two decades.
Strong finances and the lack of imbalances are the payoffs from the new corporate prudence. Typically, cutbacks in capital spending and inventories are the two biggest drains on economic growth in a recession. This time, a lean corporate sector may turn out to be a stabilizing influence, and it will be able to gear up quickly once the economy begins to recover.