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Will less business spending stall growth?

A surprise in Friday's GDP data: The slowest rise in corporate investment in two years.

The Arkansas River weaves an aquatic slalom course past Wichita's downtown office buildings, but the city also has another river – a flow of investments – that's helping to create new Kansas jobs.

As America's hub of small-aircraft production, Wichita has benefited from a strengthening aviation climate. And as a Grain Belt city, it's reaping new growth from ethanol's popularity as an alternative fuel.

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This flowing river of capital is vital to Wichita's prosperity. But as far as business investment on a national level is concerned, Wichita's recent success may be the exception rather than the rule.

The US economy grew at a cooler pace in this year's second quarter, the Commerce Department reported Friday, and one reason was slower-than-expected investment by businesses.

"We don't just rely on consumption" for economic growth, says Peter Morici, an economist at the University of Maryland. "We also rely on investment."

The economy grew at a 2.5 percent annualized rate in the April-to-June quarter. That's down from the 3.2 percent growth the economy reached in 2005, and slower than forecasters were expecting.

Consumers are always the economy's mainstay, accounting for more than two-thirds of the nation's gross domestic product with their purchases of goods and services. But business investment is another major contributor to GDP. And employment numbers blossom when businesses invest, with paychecks that allow consumer spending to increase.

This year, many economists hope that strong corporate spending will offset slower consumer momentum. But in the second quarter, at least, that didn't happen.

Business spending advanced at just 2.7 percent, its slowest quarter in more than two years. Meanwhile, consumer spending also cooled off, growing at a 2.5 percent rate – but that downshift was expected.

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"The consumer side wasn't that bad," says Michael Darda, chief economist at MKM Partners, an investment firm in Greenwich, Conn. The economy's failure to match forecasts "was really the result of this sharp slowdown in investments and exports."

While Mr. Darda predicts that weak business investment is only temporary, some experts worry that tepid corporate investment may persist.

The varied views reflect a wider debate over whether the economy is now slowing abruptly toward a possible recession, or merely hitting a speed bump on the way to continued growth.

The Federal Reserve has been raising short-term interest rates since 2004 in a bid to hold inflation in check. But consumer prices have been rising at a faster clip, even as higher interest rates begin to crimp consumer spending power. Despite an inflation uptick evident in the new Commerce Department report, investors pushed stock prices higher Friday on expectations that the slowing economy will prompt the Fed to pause when it meets Aug. 8, breaking a string of interest-rate hikes.

Darda is optimistic that solid growth will return in the year's second half, at perhaps a 3.5 percent annual pace. And he expects the Fed to raise interest rates again some time this year.

Both consumers and businesses will play a part in that outcome, he says. A strong job market will keep wages rising, allowing consumer spending to remain strong despite the impact of high energy prices and a cooler housing market.

"The tight labor market is going to trump the housing slowdown," Darda says.

The jobless rate in Wichita, where businesses are continuing to invest, has fallen from 6.9 percent in 2003 to 4.4 percent today.

The business mood is also improving, says Patrick French president of economic development at the Wichita Area Chamber of Commerce, and "we're seeing that unemployment rate come down quite a bit."

High employment, which is pervasive throughout the nation, should help businesses maintain the confidence to continue investing. They certainly have the means to do it. Corporate profits have been strong for four years, providing a ready supply of cash. With long-term borrowing costs also relatively low, it's the kind of environment where capital spending often flourishes.

Dr. Morici, in Maryland, sees another factor at work: the tide of imported goods that has created a record US trade deficit.

American exports are growing, but not as fast as many hoped. And they are dwarfed by the influx of goods from abroad – everything from apples to apparel to flat-screen TVs.

In effect, much production and business investment is happening overseas rather than in the US.

"A lot of [US] companies are buying back their stock," rather than investing in new equipment, says Morici. "They don't see a lot of growth in the domestic market."


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