Savannah Chamber

14 8 Businesses' Capital Spending Due to growth of end markets, still tight labor markets, technological advances, competitive pressures, and less regulation business spending for nonresidential fixed investment will be only about two percent larger in 2020 than in 2019. That percentage increase could easily be two or three times as large should trade tensions loosen appreciably. As things stand, nonresidential fixed investment will be a weak tailwind to U.S. GDP growth but has considerable upside potential should the trade war be resolved. The need to improve productivity, good cash flows, and access to inexpensive credit will support such spending. In early 2019, the ratio of liquid assets to short-term liabilities was 83 percent, or more than double where it stood 10 years ago, which bodes well for investment spending by businesses. With the economy still operating close to full employment, the limited supply of workers normally would incentivize businesses to substitute capital for labor, but the trade war creates too much uncertainty. Too many businesses therefore are not moving forward with capital spending. Downside risks to business spending for investment include escalation of the trade war, lower levels of business confidence, lower corporate profits, lower stock prices, and possible turmoil in the financial markets. Due to top line growth, better access to credit, investment spending by small businesses should grow. Home price appreciation is adding to home equity, which is a major source of collateral for many small business loans. Fewer federal regulations and tax reform also will help small businesses justify higher outlays for structures, equipment, and intellectual property. The main negatives are uncertainly regarding trade policy and lower confidence in the economic situation. Each escalation of the trade war crushes animal spirits, and, in turn, capital spending. By historical standards, businesses' capital spending has been very weak. Consequently, there is a need to increase spending on nonresidential fixed investment despite low levels of capacity utilization. That is because the capital stock is getting quite old. The age of nonresidential fixed assets across all private industries is at its highest level in 66 years. Indeed, businesses have spent aggressively on stock buybacks and acquisitions, but have not spent aggressively on equipment and other forms of capital that raise productivity. Investments have been deferred for so long that replacement needs should raise capital spending, but low levels of business confidence and high levels of uncertainty regarding trade policy are likely to postpone such spending yet again. It helps that lending standards will not tighten appreciably. In addition, for many companies, cash flows will be adequate relative to the amount of funds they need for investment. Capacity utilization will not be a tailwind for business spending for equipment and software. Indeed, in this cycle, the U.S. economy never reached the point where GDP growth generates more GDP growth because inadequate capacity begins to encourage more capital spending – the accelerator effect. Normally, the capital spending accelerator would have already kicked in earlier in the economic cycle, which is one reason why this has been a subpar economic expansion. The rate of capacity utilization in all industries was 78.8 percent in mid-2019, which is up considerably from its low point of 66.7 percent in 2009. Nonetheless, the long-run (1972-2018) average rate of capacity utilization for all industries in the U.S. is 79.8 percent. Because the rate of capacity utilization is still below its long-term average, capacity utilization will not spur capacity additions in 2020. Capacity utilization varies by industry, with some major subsectors operating above, or below their long-term averages. For example, in mid-2019, capacity utilization for industries producing crude goods was 87 percent, a rate 0.9 percentage points above its long-run average. Capacity utilization at the primary and semi-finished stages of production was 75.4 percent, a rate 5 percentage points below its long-term average. Capacity utilization for goods at the finished stages of production was 75.1 percent, a rate 1.7 percentage points below its long-run average. Corporate Profits Corporate profits, which are already at very high levels, are expected to decline in 2020. The much slower pace of U.S. GDP bodes poorly for growth in domestically generated corporate profits. Meanwhile, labor markets will push up wage and benefit costs, which will be a headwind for corporate profits. The trade war is both a headwind and a recession risk for both top-line and bottom-line growth. Tariffs, trade tension, and slower expansion of foreign GDP – especially in the EU and emerging markets – will limit sales prospects for many export-oriented companies. Past appreciation of the dollar makes it expensive for companies to convert earnings in foreign markets to dollars. The dollar's value will moderate only slightly in 2020, which will not provide much help to profit growth based on overseas earnings. Businesses' pricing power will not firm dramatically. It will be difficult for companies to raise prices enough to pass on

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