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Economic Insights

If the financial health of U.S. companies is so strong, why aren’t managers stepping up the pace of hiring and capital spending?

The market’s recent volatility has developed in response to at least one inscrutable fear and two fundamental matters. The inscrutable fear is Ebola. There is no way to forecast this sort of thing, no way carefully to weigh probabilities. Its impact emerges from periodic thinking about the worst. There is little that this column can offer here except to note that “the worst” seldom happens. One of the fundamentals is the mess in Europe. This space has offered a lot of commentary on this matter, little of it encouraging. (The latest piece, “Europe: Draghi’s Deflation Desperation,” appeared on October 13.)  The other fundamental is the pace of this country’s economic recovery. Here, hopes of a durable acceleration alternate with the reality of disappointing results so far in this recovery. Other Economic Insights have dealt with this question, most recently the one on November 24 (“U.S. Economy: Getting a Fix on Growth”). This column turns to evidence of the ongoing economic sluggishness and why, though recession is highly unlikely, the growth rate likely will remain disappointingly slow.

At the root of much of the recovery’s substandard character is the extremely cautious behavior of corporate managements and small-business owners. Firms surely have the wherewithal to support more aggressive rates of expansion. Profits and margins are strong, as are business balance sheets, remarkably so in fact. Yet, managements seem to lack the confidence they need to hire and spend and so drive the economy forward. The great economist John Maynard Keynes referred to this quality as “animal spirits.” And so hiring has remained historically restrained and so also, accordingly, have household incomes and spending, at least relative to past recoveries. Spending by businesses on new facilities, equipment, systems, and intellectual capital also has remained historically restrained. Nor are their signs of a change in such patterns, at least not significant enough to alter the substandard character of this recovery.

They Could Be Much Bolder
Certainly, managements have the resources to be much bolder than they have been. Non-financial corporations, for example, have seen the value of their financial assets jump 4.7% a year since 2009 and 4.8% a year since 2012. Their cash on hand has increased during these two periods at annual rates of 3.3% since 2009 and a whopping 5.8% rate since 2012. Cash holdings now exceed 10% of total liabilities. The value of their real estate assets have increased at a 9.1% annual rate since 2009 and at a still stronger 12.5% rate since 2012. Total assets have jumped at annual rates of 5.6% and 5.4% during these two respective periods. Business caution has, however, so held down the growth of liabilities that their net worth has jumped 6.5% a year since 2009 and 6.6% since 2012.1    

This story of improvement and caution is much the same for smaller business. Nonfinancial, non-corporate firms in the United States have seen their total assets expand 9.5% a year since 2012. Their cash holdings have grown less impressively than those of larger companies, but like their larger brothers and sisters, caution in these smaller firms has held back increases in liabilities, which have expanded at only a 1.2% annual rate since 2009 and only a 1.9% rate since 2012. Their net worth, accordingly, has jumped at a 7.8% yearly rate since 2009 and a 6.6% rate since 2012.               

Despite the impressive improvement in business’s financial resources, two considerations in particular have fostered continued reluctance. First is the legacy of the Great Recession of 2008–09—perhaps “wounds” is a better word. During that difficult time, managements came up short on several counts. Many report that they had trouble making payroll. The financial crisis that accompanied the recession exaggerated such pressure. Many small and quite a few larger firms found lenders less than eager to honor lines of credit previously arranged. Little wonder, then, that managements remain reluctant to use their assets and their cash as fully and as aggressively as they once did. On top of these powerful influences, Washington, beginning in 2009, passed a great deal of complex legislation. The Affordable Care Act and the Dodd-Frank financial reform legislation stand as prominent. Whatever the merits of these laws, their complexity created considerable uncertainty among managements about the costs of hiring or credit and even the availability of credit in the future, a consideration that greatly exacerbated the reluctances engendered by the recessionary experience.

The Evidence
Business has, accordingly, hired at a slower pace than in the past. Even the 2014 pickup in the pace of payroll growth falls short of the historical standard. So far this year, according to the Department of Labor, payrolls have grown on average by 226,667 a month, up from 194,250 a month in 2013 and 186,333 in 2012.2 Though this is a welcome improvement, past recoveries in the 1980s, 1990s, and earlier in this century saw much stronger payroll gains, often in excess of 300,000 a month. Reflecting the slow pace of hiring, real incomes during this recovery have grown less robustly than in past cycles. The lavish use of overtime and an upgrading in the average skillset of new employees have helped overcome some of the effects of the hiring shortfall, but not enough to change the adverse comparison. So far this year, overall real personal income has accelerated to a 3.6% annual pace of increase, from negligible growth in 2013 and 2012. Though this too is a welcome improvement, the established trend nonetheless remains well below that of past cyclical recoveries.

These increases are good enough to sustain consumer spending, and give some hope of an acceleration going forward, but nothing to match past cyclical recoveries. The strain is not just that households have seen their spendable resources grow along a shallow slope but also that their sense of the shortfall, and the still constrained jobs market, has kept them from extending themselves as they once would have. To be sure, this caution on the part of households does guard against an overextension that might, in time, lead to a bust, but it also blocks a rise to that happy medium between excess and greater levels of economic activity.    

Managements have remained reluctant to spend and expand in other ways as well. The most telling sign here is how little their capital spending exceeds ongoing rates of depreciation. In past recoveries, companies quickly increased spending on new equipment, premises, and intellectual capital, increasing it on average from barely over depreciation during the recession to almost 45% above rates of depreciation in the early stages of recovery and even higher later in the expansion. But this time their caution has held them back, so that new spending on equipment, premises, systems, and intellectual capital, even after years of albeit slow recovery, still barely exceeds depreciation rates by 20%, less than half the historical average. Apart from directly holding down spending flows into the economy, this relatively timid behavior also limits future potentials for productive capabilities, productivity, hiring, and upgrading.3  

If Not Now, When?       
Sadly, there is little sign that the old “animal spirits” are likely to return quickly. Time, no doubt, will erase the bad memories of 2008–09 and perhaps permit more aggressive behavior among business managers. But as the evidence just presented indicates, it likely will take considerably longer before behavior changes substantively, and then the turn likely will occur only slowly. Meanwhile, the uncertainties connected with Washington’s ambitious legislation linger. Regulators have yet to write, much less clarify, many of the rules connected with the Dodd-Frank financial legislation, leaving all in business and finance up in the air about costs, availability, even required procedures in getting credit. There was some hope as 2014 approached that a full implementation of the Affordable Care Act would clarify its costs, benefits, and burdens. But so much of the bill has been modified temporarily—some for indefinite periods—that the most oppressive uncertainties remain in place. And all this offers ample reason to expect that this recovery will continue to remain historically slow, if perhaps not quite as substandard as it has been this far. 

 

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