For two years now, the tech sector has been the focal point of this business cycle. The recession began with a tech-sector bust as the stock prices of dot-coms, computer makers, and software companies collapsed, leading to an investment-led downturn in the economy. Now, everyone is waiting for tech spending to regain momentum and begin to power an investment-led recovery that workers, executives, and investors can actually feel.
Well, here's a news flash: The rebound in capital spending for high-tech equipment, some 55% of all equipment outlays, is already well under way. A BusinessWeek analysis of Commerce Dept. data shows that what's holding back business investment is traditional machinery, such as engines, turbines, and transportation equipment (chart).
Now more than ever, capital spending serves two different purposes for businesses: High tech means productivity, while low tech means expansion. For instance, computers and software can increase the output efficiency at a plastics company and lower the cost of making one of the company's products. Those innovations can help the bottom line when demand is weak. But as demand picks up, increased productivity can go only so far. The company will need more injection molders, extruders, and buildings to house them.
To be sure, the economy's favorable structural trends for productivity, inflation, and standards of living are rooted in high-tech innovation. But short-term, tech won't be the recovery's savior. This upturn must enter the expansion phase, when companies hire more workers and invest in new plants, furniture, and basic machinery. The oft-overlooked low-tech sector will be the place to look for signs that demand is strong enough to justify increased payrolls and capacity that will generate faster growth in household income and profits.
SO FAR, THOUGH, BUSINESSES are concentrating on productivity and ignoring expansion. The data show that real business outlays for information-processing equipment such as computers, software, and other office gear have risen in each of the past four quarters, for a total gain of 9.2% over the past year. The volume of tech outlays has actually regained almost all of the 10.5% drop suffered during the recession.
That's after adjusting for declining tech prices, a trend that is helping to depress profits and the stocks of many tech companies. But thanks to those falling prices, which reflect advances in technology, businesses economywide are able to boost their computing capabilities without increasing their tech budgets (chart).
The rebound in tech outlays reflects how the structure of this economy is evolving. Simply put: Companies know that relentless competitive pressure demands the edge that technology can provide. That's why businesses will continue to focus on productivity enhancement.
Don't worry that the recession losses in equipment investment will stunt the heightened long-term growth rate of productivity. Since peaking in the third quarter of 2000, real capital spending on all equipment fell 10.7% during the recession. That drop is in line with previous recessions, which saw peak-to-trough declines in equipment outlays ranging from 5% to 11.9%.
Moreover, the drop in outlays for tech equipment has been accounted for largely by the bust in telecommunications equipment, which accounts for one-sixth of real overall spending on tech gear. Outlays for telecom gear plunged 31% from the end of 2000 to the end of 2001. They have stopped falling but have gone nowhere during the past year.
By contrast, over the past five quarters, real business outlays for computers and peripheral equipment, which account for one-half of all tech outlays, have grown at an annual rate of 28%. That's nearly as fast as the 32% annual clip from mid-1998 to mid-2000--the height of the boom. Excluding telecom, the recession decline in real outlays for tech equipment was confined to only two quarters and amounted to only about 5%. Minus the drag from telecom, tech outlays are now about 8% higher than their pre-recession peak.
HOWEVER, BUSINESS SPENDING on low-tech industrial machinery is lagging far behind. Those investments began to fall two quarters before the downturn in tech spending began. The two-year dropoff, twice as long as the tech decline, was greater in both percentage and volume. Only at the end of 2002 did this sector start to bottom out.
Perhaps the biggest drag on spending for expansion is the rise in global risk. As Federal Reserve Chairman Alan Greenspan said in his semiannual congressional testimony on monetary policy on Feb. 11: "Indeed, the heightening of geopolitical tensions has only added to the marked uncertainties that have piled up over the past three years, creating formidable barriers to new investment and thus to a resumption of vigorous overall economic activity." In other words, business won't expand while Iraq clouds the future.
Another reason for the sluggishness in more traditional capital equipment is the collapse of commercial construction, which has fallen 25% over the past two years. That drop is greater than the real estate collapse in the early 1990s related to the savings and loan meltdown. Vacancy rates remain generally about double what they were two years ago. Not surprisingly, outlays for office furniture and other low-tech office staples have followed business construction lower. Such outlays are also down 25% from their peak in 2000.
WITH EXPANSION ON THE BACK BURNER and efficiency gains at the forefront, it is not surprising that payrolls continue to go nowhere. The Labor Dept. reported that in January, employment increased by 143,000 workers, but that followed a 156,000 drop in December. The pattern mainly reflected less hiring by retailers during the Christmas season, which meant that fewer retail employees were laid off in January. The drop in the January unemployment rate, from 6% to 5.7%, also looks suspect.
On balance, the labor market appears to have stabilized, but the economy is still not growing fast enough to generate healthy job growth that will bring a lasting drop in the unemployment rate. Part of the reason is the success businesses have had in boosting productivity. Despite losing more than one million jobs over the past five quarters, the economy still grew at an annual rate of 2.8%.
That pace used to be considered decent, but now it will take much faster growth to lift payrolls and profits. However, that pace won't be reached until war uncertainties have passed. Then, look for the expansionary effects of low-tech capital spending to kick into high gear even as the ongoing imperative to edge out the competition keeps tech outlays rising. That's when the recovery will start to feel like one.
By James C. Cooper & Kathleen Madigan