Is business investment gap stalling recovery?
Is business investment gap stalling recovery?
Weak levels of business investment are holding down wages and job gains.
Tim Mullaney, USA TODAY
8:02 p.m. EDT September 22, 2013
When the financial crisis hit in 2008, aluminum prices crashed nearly as fast as stocks.
So aluminum giant Alcoa did what it had to: It slashed capital investment, to $1.6 billion in 2009 from $3.4 billion a year earlier. It never came back. With prices still low, Alcoa's yearly investment is now $1.3 billion and falling, concentrated in a handful of specialty businesses that are still growing. Its stock has lost three-fourths of its value. And effective Monday, Alcoa is out of the Dow Jones Industrial Average.
"They're not generating as much profit, so they can't invest,'' Citigroup analyst Brian Yu says. "They're putting their capital where it makes the most sense.''
Five years after the crisis, the "investment gap'' that Alcoa exemplifies stands as one of the most enduring and disabling legacies of the Great Recession. Companies have held off on spending as much as $2.2 trillion since 2008, estimates the Progressive Policy Institute in a new report — more than $500 billion just last year. That's translating into lower productivity growth, slower economic growth — and fewer new jobs.
"When workers have older and less equipment, they produce less,'' PPI Chief Economic Strategist Michael Mandel said. "It's a very simple connection.''
It means lower wages, too. Median household incomes are still about $4,500 below 2007 levels, adjusted for inflation. One major reason is that low productivity growth means profit margins are narrower — and that shrinks the pot of money that raises are drawn from, even with corporate profits still near all-time highs, says Carl Tannenbaum, chief economist at Chicago-based Northern Trust.
Excluding the energy industry's shale oil boom, investment economy-wide is lower than in 2007, Moody's Analytics says
The problem is widespread, at even the zenith of American business.
Among the Dow industrials, companies such as Home Depot, General Electric, Cisco Systems, IBM, Visa and Johnson & Johnson are all still below 2008's capital spending. Dow component 3M's capital spending hasn't kept up with inflation, according to regulatory filings.
The biggest factor holding up investment is executives' still-shaky confidence, said Frank Friedman, chief financial officer of accounting firm Deloitte, which does regular surveys of CFOs. That will only ease when the economy posts stronger monthly job gains than it has recently, he said. Since April's gain of 199,000, the economy has averaged only 155,000 in the following four months.
"What drives confidence is seeing people get hired in the private sector,'' he said. "CEOs need confidence to make investment."
Corporate reticence, at a time of outsize profits, puzzles economists and policymakers. In a sign of the gap's persistence, PPI estimates that businesses invested $508 billion less in 2012 alone than they would have if spending had kept growing at its 1997-2007 pace. Investment saw little growth in the first half of this year, according to the Commerce Department, even after Congress and President Obama avoided the fiscal cliff.
By one arcane measure that the Federal Reserve tracks, U.S businesses are investing less than during any recovery since at least 1952 — even though they're so awash in cash, they needn't borrow to invest at a more normal clip, Barclays economist Dean Maki said.
The problem is still getting worse, according to some studies. Global corporate investment is likely to drop 1.5% this year and is set to fall as much as 5% next, Standard & Poor's economist Garth Williams said. In the U.S., investment will drop 1% this year and 3% next, he added.
"The global recovery will be slower and weaker than people might hope for,'' Williams said. "Investment adds to a recovery once it's underway, and that's at risk.''
No investment = no raise
Why is this a big deal?
Because investment drives productivity growth, and productivity ultimately makes rising wages possible, Tannenbaum said. If the cost of making a $100 item goes to $70 from $80, the $10 saved can be split between wages, profits, and more investment, he said. Substantially all wage growth in the history of capitalism traces back to higher productivity, he says.
Yet, the last two years were the weakest stretch for productivity growth since 1983-84, the Labor Department says. The Labor Department's report on second-quarter productivity showed a 2.3% annualized gain, but it followed such weak performance in late 2012 and early this year that the last 12 months show only a 0.3% gain. Productivity rose five times faster during the Internet boom in the late 1990s and its aftermath, as the productivity pop from investments made by 2000 persisted for years afterwards.
That investment helped drive wage growth in the late 1990s — and the lack of it is holding wages back now, economists say.
"Investment is the foundation of growth," said PPI economist Diana Carew. "With more investment, everything we think is lackluster now would see bigger gains.''
Policymakers agree. The minutes of the Federal Reserve's July meeting show members of the Open Markets Committee saying more investment is ''likely to be a necessary element of the projected pickup in economic growth.'' But the minutes add that "reports from businesses range from contacts who expressed heightened optimism to those who suggested that little acceleration was likely in the second half of the year.''
The most recent data complete the picture that opinion leaders paint.
July's orders for core capital goods — which excludes the volatile aerospace sector — showed a drop of 1.5%. "Quite ugly," economist Joel Naroff called the report. That impression was only partly leavened by bullish signals from an Institute of Supply Management survey on manufacturers' confidence, and another from the Philadelphia Federal Reserve on Sept. 19.
"The U.S. equipment sector has stalled in the past year — through both the start of the Fed's (third stimulus) program and talk of tapering now,'' Action Economics Chief Economist Mike Englund said. "Growth has been hit by a diminishing cyclical rebound in the auto sector, defense cuts ... and a disappointing 2013 pace for non-residential construction.''
The good news is that capital spending usually grows faster than the economy as a whole during the second half of an economic cycle, which would imply some acceleration next year, probably after a weak third quarter, said John Canally, chief economic strategist at LPL Financial.
"I wouldn't say it will be a robust, '90s-syle spending binge,'' Canally said. "But at the margin, it should be OK.''
Big risk, big rewards
The payoffs from investing enough can be large — though, like any investment, capital spending isn't a sure thing.
At Ciena, a Maryland telecom-gear company, CEO Gary Smith doubled investment beginning in 2009. Ciena needed to innovate before rivals devised products for the surge toward cloud computing, Smith said. That meant adding proprietary software and other features to Ciena gear, he said.
"The culture of our company is to play for the long term," said Smith.
Adjusted operating-profit margins that dipped into the red during the recession are back to 8% again with help from new products, he said. Third-quarter product sales climbed 17%, driven by the new machines developed with that money.
Corporate giants such as Verizon Communications and Intel show how investing through the downturn paid off. Alcoa is one example of what can happen when executives try to hold the line.
Intel has doubled capital spending since 2008 and will add another $1 billion this year, reaching $13 billion, spokesman Chuck Mulloy said. New U.S.-based factories have let Intel widen profit margins and add 25,000 jobs since 2008, he said.
Verizon poured $23 billion into its FiOS broadband network since 2004, and has spent billions more to upgrade its Verizon Wireless network to 4G technology, Chief Technology Officer Anthony Melone said.
The results: Verizon's margins in its wireless business have reached an industry-best 50%, up from 46% in 2008, enough to boost profit on the $80 billion business by as much as $3 billion. Verizon's 6% subscriber growth in the last year is nearly twice the industry's pace. All that drove Verizon's Labor Day weekend deal to buy the 45% of Verizon Wireless it doesn't already own from UK-based Vodafone for $130 billion.
Meanwhile, FiOS — a triple-play bundle of TV, broadband Internet and phone service — is generating nearly $11 billion in yearly sales, growing 15% in the second quarter. It has also let Verizon hang on to millions of wired-telephone customers, Melone added.
"You have to have the stomach to do it,'' he said.
Companies that have cut investment are often in the midst of transitions to new ways of doing business, including Alcoa. With basic-aluminum prices depressed, it has preserved investment in new, higher-value products while cutting older businesses.
"Some (of our) businesses are under enormous stress," CEO Klaus Kleinfeld said in an earnings conference call July 9. "Two big areas are aerospace and automotive, and we are putting capital in there. We are growing in this."
One industry hit especially hard by the investment drought is retailing.
Retailing was one of the spectacular successes of the 1990s productivity boom, as rivals spent heavily to keep up with Wal-Mart's cost-cutting innovations. But spending has slowed. In 2012, with consumer spending rising modestly, productivity growth picked up from post-recession lows but remained half of what it was a decade earlier and below its long-run average, government data show.
Home-improvement chain Lowe's has cut capital spending to $1.2 billion from $1.8 billion, a plunge that spokeswoman Chris Ahearn attributed to shifting from opening 150 stores a year to expanding Lowes.com. Similarly, Macy's cut investment after renovating newly acquired stores in the mid-2000s, spokesman Jim Sluzewski said. Macy's spending has nearly recovered to pre-recession levels, after inflation.
Most retailers say they'll boost investment 5% or less this year, according to a survey by KPMG. Many will lose more market share to Amazon.com, which has boosted capital spending 11-fold since 2008 and seen its stock quintuple, said Mark Larson, head of KPMG's retailing practice.
"When the downturn hit, retailers really retrenched,'' said Larson. "Now they'll invest, but it's modest.''
http://www.usatoday.com/story/money/business/2013/09/22/business-investment-productivity/2455427/