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%.

Three factors supported this growth. First, despite the generally slow pace of the recovery, corporate profits surged, initially by upwards of 50%, giving a wide variety of firms the wherewithal to finance such spending. Second, the flood of ambitious legislation developed during 2009—in particular Obamacare—left many business managers unsure of how much new employees would cost and eager to reorient their operations away from hiring and toward a greater reliance on equipment. Third, in September 2010, Washington passed temporary legislation that allowed smaller businesses to reduce their tax bill by expensing outlays for new equipment instead of writing the cost off gradually through depreciation. That tax break induced managers to hustle whatever spending they had contemplated to get it recorded while the government held to its generous policy.

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