Recent economic reports suggest the US economy might have expanded even more than the initial 3.5 percent estimate in the third quarter, and wages finally began to lift as the labor market pushed further into full employment territory. But an abrupt slowdown in capital expenditures threatened to cast a shadow over the bright economic scene.
Businesses base their investment decisions on expectations for revenue growth, and cutbacks can provide an early warning of a deteriorating economic outlook. When capital expenditure growth came to a near standstill in the third quarter—expanding at just a 0.8 percent annualized rate after growing at a double-digit pace in the first half of the year—many analysts were concerned. Ongoing investment in capital goods is required to build up the nation’s productive capacity and meet rising aggregate demand as the economy expands, so a sustained slowdown in capital expenditure could eventually stifle growth.
Fortunately, the third-quarter falloff in capital investment is likely to be short-lived. The decline was narrowly concentrated in outlays for transportation equipment. A pullback in transportation spending should be no surprise when automotive manufacturers are beginning to see capacity constraints. Last quarter’s falling invoices were likely a reflection of backlogged orders for vehicles, not a dimming outlook for revenues.
Trends in capital investment can provide an important barometer of economic health, but data from any single quarter will be inherently volatile. Over the course of the current expansion, business investment has repeatedly reached double-digit growth rates in strong quarters, only to fall back to a near standstill within the span of a year. During the global oil glut of 2014, overall capital investment briefly declined as oil exploration ground to a halt. But despite these fluctuations, the economy’s productive potential has continued to grow. A sudden drop-off affecting a single quarter shouldn’t be mistaken for a meaningful trend.
A detailed look at capital investment activity shows that the slowdown was narrowly concentrated. For example, investments in intellectual property like software updates and research and development projects maintained an 8 percent growth rate through the third quarter. Steady spending in these areas implies confidence in the economy’s growth potential—businesses still recognize the necessity of developing future revenue streams and harnessing new technologies.
However, construction activity weakened considerably, accounting for a significant share of the previous quarter’s decline. But quarterly figures for nonresidential construction are especially volatile; the total can be skewed by a handful of major projects. It wouldn’t be surprising if construction’s share of capital investment quickly rebounded—oil prices have stabilized in the break-even territory for shale field exploration, and the resurgence of horizontal drilling activity is likely to support stronger construction activity in the coming year.
Businesses continued to spend on industrial machinery and new computers in the third quarter; however, these purchases were almost entirely offset by a sharp decline in transportation investment. Spending on new fleet vehicles contracted at a 9.1 percent annualized rate for the quarter, bringing the broader category of equipment investment down to a stagnant 0.4 percent annualized growth rate.
Businesses abruptly cut transportation spending in the third quarter, but the overall transportation sector is quite robust. New vehicle sales are on pace to sell 17 million units in 2018, and consumer spending on vehicles climbed at a 4 percent annualized rate through the third quarter. Some of the spending decline among businesses may have been due to a simple measurement error if statisticians underestimated the share of vehicle sales assigned to commercial customers.
Backlogged orders could also be playing a role. Automobile, truck and trailer manufacturers are operating close to their full capacity, and the volume of backlogged vehicle orders has reached a two-decade high. Capacity constraints would naturally be expected to curtail purchasing activity—if businesses aren’t seeing their orders filled quickly, they may choose to postpone further investments until the industry’s capacity to deliver on sales improves.
Worries about falling transportation investment are likely misplaced. The automotive sector’s outlook is quite strong, with consumer demand straining against the industry’s productive capacity. The third quarter decline in fleet sales is most likely a supply issue, not a failure of demand.
Economic growth depends on capital investment, but there’s little reason to believe that businesses are hesitating to purchase new equipment, construct new facilities or invest in research and development projects. Weak expenditures in the third quarter were a surprise, but the slowdown will likely prove transitory as businesses continue to build up their productive capacity in anticipation of strong future demand.
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