Capital Spending Runs Out of Steam

Expiring tax break has dampened corporate demand for capital goods.

Milton Ezrati of Lord AbbettBusiness spending on capital goods, once an area of considerable relative strength, has weakened of late. When the spending pickup began earlier in this recovery, the utilization rates for existing facilities were so low that many expressed surprise. Only a little of the spending went for increased capacity, of course. Most of it was aimed at labor-saving equipment. Though this focus held back the pace of hiring, it did contribute to economic growth. While Tuesday’s report on October non-defense capital goods purchases showed a 0.8% rise, most of this year’s data suggest the demand has run its course and the capital spending sector, too, has fallen into the slow slog that has typified much of the rest of the economy for some time now. 

From the beginning of this otherwise disappointing recovery, spending on new equipment showed remarkable strength. While overall real gross domestic product grew at 2% a year or less, the Commerce Department noted that from mid-2009 to year-end 2010, new orders for non-defense capital goods surged at a 17.1% annual rate. In 2011, even as the already sluggish economy slowed still further, the pace of new capital goods orders accelerated, growing almost 30%.

But orders hit a wall this year. Non-defense capital goods orders, according to the Commerce Department, fell at an annual rate of almost 27% annual rate during the first half. Between June and August, such orders dropped at a 74% annual rate. September saw some recovery, but orders still have fallen at an annual rate of nearly 4% over the year so far, a radical shift from the previous strength.

In part, the slowdown should come as no surprise. Washington has long indicated that the tax benefit that allowed firms to expense instead of depreciate spending on capital equipment would end in 2013. As the year progressed, business realized that any further orders would turn into spending only in the coming year, by which time they would no longer be eligible for the tax break. No doubt these gyrations will smooth out in the new year, as Washington’s on-again, off-again approach ends, but to some extent the effort to get as much done while the breaks were in place has stolen spending from the future. Any future gains, consequently, will remain slow for some time to come.

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