The Capital Goods Trade Surplus Is Shrinking Fast

One of the distinctive features of the current expansion has been the unusually strong role of equipment investment, which has accounted for roughly half of the economy's growth since the recovery began. But although capital-spending plans remain robust, economist Bruce Kasman at Morgan Stanley & Co. warns that two trends could upset the investment apple cart and slow economic growth: the sharp decline in capital investment in other industrial nations and the fast-rising import share of U.S. equipment purchases.

In the normal pattern, upswings in capital expenditures in the U.S. tend to spread quickly throughout the industrial world, producing synchronous investment cycles. This time around, though, capital spending in other advanced economies has stayed weak, contracting at close to a 5% annual rate since 1991. What's more, a significant pickup is probably years away.

For one thing, both Japan and Europe are still trying to deal with huge overhangs of excess capacity created by major investment booms a few years ago, when Japan's bubble economy and the prospect of European unity inspired wholly unrealistic sales expectations. For another, industrial economies overseas are only in the first stages of the kind of cost-cutting and downsizing that turned American industry lean and mean over the past decade. Until it is well advanced, the process of restructuring to meet intensified global competition tends to slow capital spending rather than stimulate it.

This spells big problems for America's lagging trade balance. Capital goods now account for some 40% of U.S. merchandise exports, of which more than half normally go to other industrial nations. At the same time, foreign-made equipment, which now accounts for 25% of U.S. imports, continues to make sharp inroads in U.S. capital-goods markets. Even as the dollar declined, the import share of domestic nonautomotive equipment spending has climbed from 30% in 1986 to some 50% today.

Thus, plummeting capital investment abroad is restraining U.S. exports at the same time that surging capital spending at home is sucking in imports. In fact, notes Kasman, "roughly half of the $60 billion widening of the U.S. trade deficit since the end of 1991 can be traced to the dramatic decline in America's surplus in capital-goods trade." In short, in a world in which capital spending overseas is inhibited, a U.S. investment boom can be a mixed blessing.

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