Capital Spending: The Best Is Yet To Come

It's hardly news that Corporate America has been shelling out big bucks for equipment in recent years--particularly for computers and other information technology that enable companies to raise productivity and output while restructuring their workforces. Now, however, there are signs that capital spending is gaining momentum and broadening its scope. The result, says economist Stephen S. Roach of Morgan Stanley & Co., could be "a major capital spending boom that rivals the spending spree of the late 1960s and early '70s."

While real outlays for information technology soared at a 31% annual rate in the final quarter of 1993 (and were up 27% for the year as a whole), Roach notes that spending on heavy industrial equipment and structures also accelerated in the fourth quarter--posting annual rates of 22.4% and 10.3%, respectively. "Business investment," he says, "finally appears to be looking beyond restructuring to capacity expansion and updating of the basic capital stock."

Underscoring the trend is the government's latest survey of capital-spending plans, which projects a 9.8% rise in real outlays in 1994, up from 7% projected late last year. And the March survey of the National Federation of Independent Business indicates that 38% of small businesses plan capital outlays in the next six months, the most since the monthly survey began in 1986.

Economists point to three developments that suggest the investment surge will persist. The first is growing capacity constraints. In March, the operating rates of a number of industries--lumber, primary metals, computers and office equipment, motor vehicles, textiles, paper, mining, and petroleum products--clocked in above 90%, and electrical machinery came in at 85.5%

At the same time, economist Joseph Carson of Dean Witter Reynolds Inc. notes that the ratio of the market value of corporate stocks to the current or replacement cost of physical assets moved above 1 last year for the third year in a row, hitting a record 1.38. (It's still comfortably above 1, despite the recent market decline.) According to a theory originated by Nobel laureate James Tobin of Yale University, when this ratio is below 1, as it was during the 1980s, businesses tend to buy their own shares or expand by acquiring other companies. When it is above 1, on the other hand, businesses tend to invest in new equipment to produce capital gains for their shareholders.

"The last time the ratio was above 1," says Carson, "was in the 1960s, and we had an investment boom. I think history will repeat itself."

Another incentive to invest, argues economist Rosanne M. Cahn of CS First Boston Corp., is the age of the capital stock. She calculates that in 1992 and 1993 the net age of business equipment, excluding computers and motor vehicles, was the highest it has been in the entire postwar period. And the average age of industrial buildings was the highest since 1950. "If the economy stays reasonably strong," says Cahn, "replacement demand will take off."

Roach, for one, thinks the current spending boom is likely to persist. And he predicts that its widening scope will gradually shift the emphasis from downsizing to job formation.

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