The economy is going well now, but questions about the longer run remain
As the economy roars back from the pandemic’s lockdowns and quarantines, its near-term prospects look marvelously bright in just about every sector – employment and retail, capital spending and housing. But there is a fly in the ointment. For all the economy’s recent zest, it is failing to prepare for sustainable long-term growth.
Part of this concern stems from the fiscal policies currently being debated in Washington. By this administration’s own admission, it expects that its policies will have a meager growth payoff. Recent budget projections show real economic growth long-term of less than 2% a year. Politics aside, there is something else. The annual level of business spending on new facilities and equipment, as well as on technology, barely exceeds what business loses to wear and obsolescence each year. That relative shortfall creates a picture of only a meager expansion in the economy’s overall productive capacity.
Within a constrained time horizon, say 2021 and 2022, matters look bright enough. Business spending on new capital goods is coming back nicely from the hiatus imposed on the economy by the pandemic strictures. Having declined at a striking 17% annual rate during the first half last year, overall capital spending in real terms has surged at a 16% annual rate for the three quarters since the economy began its tentative re-opening last summer.
But construction of new warehouses and factories and shops has lagged. Indeed, such spending has continued to decline through this year’s first quarter, the most recent period for which data are available. That is understandable, given the commitment involved in new construction as well as uncertainties about the impact of work-from-hone practices on more permanent post-pandemic basis. Otherwise, business seems to have splurged on modernization. Spending on new equipment has jumped at a 35.7% annual rate during the last three quarters, and spending on what the Commerce Department refers to as “intellectual property” – new systems and technologies – has risen at a 16% annual rate.
New orders data suggest that the bounce back will continue for at least a while longer. Orders for new capital equipment during the three months ended April (the most recent period for which complete data are available) have risen at a torrid annual pace of over 50%. In April, orders for new capital goods stood 41.8% above where they were last spring.
To be sure, much of this spending comes from airlines as they upgrade their fleets in anticipation of a renewed public interest in travel. But even excluding the new aircraft orders, the figures for other capital goods rose at a very respectable 15% annual rate during these recent three months for which there are data and stood some 14.7% higher than in April 2020.
This recent surge is welcome. It will contribute to the overall pace of growth and help industry and business meet future demands. That momentum should last through 2022. Beyond that time, the picture takes on a more worrying aspect. Even with this recent surge, there is reason to question whether the U.S. economy is developing the productive potential to sustain anything more than a limited long-term growth path. Outlays on new, more modern and presumably more productive equipment and technologies exceed what business loses to depreciation each year by an historically narrow margin.
According to the Commerce Department’s Bureau of Economic Analysis, the economy in the first quarter of this year saw some $2.4 trillion in productive facilities and equipment either wear out or become obsolete. That annual rate of depreciation was matched by some $3.0 trillion in new capital spending, a net addition to the economy’s productive capacity of only $600 billion. Business, for all the recent surge, is spending only 24% more on new than it is losing from what already exists, less than almost any but the most pressed economic environments in the past and hardly sufficient to build a base for rapid overall economic growth.
Perhaps the recent enthusiasm for capital spending will carry this difference over depreciation up to a more growth-oriented level, but there are reasons to doubt that scenario. This kind of limited spending over depreciation has been in place for a long time, suggesting that it will take more than post-pandemic enthusiasm to change it. And even if a change were to occur, business still has a long way to go to get to an acceptable level.
Back in the 1980s and 1990s, for instance, spending by business and industry on new facilities and equipment, as well as technology, exceeded rates of depreciation by some 50%. Even in economic reverses during those decades, that spending seldom fell below 30%. As recently as twenty years ago, industry spent 32% more on new facilities and equipment than it lost to depreciation.
Since then, the decline has extended. Of course, the sluggish recovery after the 2008-2009 great recession discouraged aggressive business spending. But even in the boom year of 2018, right after the previous administration's tax cuts should have enthused businesses, firms spent only 31% more on new than they depreciated.
Maybe this fundamental -- and by now long-lasting -- shortfall reflects the impact of globalization and its tendency to draw business spending to overseas facilities. Perhaps it reflects the general lack of optimism increasingly evident in American culture. Maybe it is a product of the U.S. tax code that so many tax analysts claim encourages financial manipulation over actual spending on productive capabilities. OR maybe it is a combination of all these things and other more obscure causes. Whatever the reason, there is no substantive change on the horizon that would reverse the trend, suggesting strongly that business and industry will slack off on capital spending once they have recovered the ground lost in the pandemic and accordingly will fail to build a productive base for rapid economic growth over the longer term.