Steady-as-she-goes prospect has US supply-sider happy
Supply-sider Paul Craig Roberts feels he has something to crow about these days. Back in 1980 he was arguing that properly designed tax changes in favor of business would stimulate the modernization and expansion of American industry. And yet the ``best and most credible and widely respected economists,'' as this former Treasury economist put it, were arguing that the corporate and personal income tax cuts then being proposed would primarily prompt more spending by consumers. This spending, combined with massive federal budget deficits, would push up interest rates and thereby crowd out business expenditures on plant and equipment. That would cause stagnation or recession, these economists argued.
``They were wrong,'' says Mr. Roberts, now with the Center for Strategic and International Studies, Georgetown University.
Congress to some degree bought the Reagan administration's supply-side arguments and put through the 1981 tax cuts -- including the accelerated cost recovery system and investment tax credits. These boosted the after-tax rate of return on capital spending.
With the economy in a deep recession, nothing much happened to capital spending at first. Many critics said supply-side economics was a failure. But in 1983 and '84, business capital spending took off.
``Look at Page 30 of the Economic Report,'' Roberts advises. On that page of the report of the President's Council of Economic Advisers, a chart notes that in the first two years of the current economic recovery, spending on ``nonresidential fixed investment'' accounted for 1.8 percent of the 6 percent real growth rate for total national output of goods and services. That is almost three times the contribution in a typical postwar business expansion.
Viewed another way, gross capital spending is up a real (inflation-removed) 25 percent so far this recovery. That's about twice the normal percentage for an expansion at this stage, noted David A. Wyss, senior vice-president, Data Resources Inc.
Roberts opposes the Treasury's proposed tax reform plan because it would eliminate the 1981 tax subsidies to investment.
Stephen S. Roach, a senior economist with Morgan Stanley & Co., the Wall Street investment banking firm, describes the ``sharpest investment rebound on record'' as ``one of the great paradoxes of this expansion.'' He figures the ``voracious appetite'' for new plant and equipment can be explained partly by the new tax incentives. The investment boom, he says, has been spurred by the rapid recovery.
Mr. Wyss also regards the tax benefits as ``a help'' to investment, thus finding ``some truth'' to the supply-side argument. He further notes, however, that capital spending was climbing from the lowest level in postwar history in 1982. It was then barely one-quarter of the average for those four decades. Net capital investment (gross investment minus depreciation) is still only about 5 percent of gross national product -- the total output of goods and services, he says.
Whatever its cause, all these economists welcome the capital spending boom. They point out that it modernizes industry, expands capacity, makes the United States more competitive internationally, boosts productivity, and thus, ultimately, should lead to higher living standards for the nation's residents.
Indeed, John Maher, an economist with Citicorp Information Services, believes the burst of capital spending may be one thing that could permit the economy to grow faster without kicking off more rapid inflation.
Here is his reasoning: As of January, industry was operating at about 81.9 percent of capacity. When it reaches a level of 83 to 84 percent on average, some strains on the supply of labor and plant and equipment begin to emerge. Manufacturers may have to use less-efficient, more-costly facilities, or hire less-capable employees. This can result in higher costs and higher prices.
The boom in plant and equipment spending, however, postpones the day when capacity reaches that trigger level.
(Wyss reckons a 5 percent boost in net capital spending this year should add about 0.5 percent to the nation's industrial capacity. In this recovery, capacity usage peaked at 82.7 percent last July, dropping a little during the autumn pause in the recovery. It climbed again to 81.7 percent in December.)
Industry, says Mr. Maher, has also been able to improve productivity by better management, as well as more modern equipment. The challenge from imports and surplus capacity, he holds, has fundamentally changed management's attitude to capital investment.
As a result of these factors, Maher says the real economy can now grow around 3 percent a year over the long run, rather than the 2.5 percent estimated earlier. This means the economy is further away from fully employing its resources of labor and capital than his economic group originally believed. That point might now be reached at the end of this year, he says.
Even then, he continues, the surge of imports could restrain domestic producers from raising their prices.
That, notes Morgan Stanley's Mr. Roach, is especially true in capital goods. More than one-third of the unprecedented surge of merchandise imports over the past two years can be accounted for by growth in foreign shipments of capital goods to this country. US companies, indeed, have been importing large amounts of high-technology goods -- an area where many have perceived the US to be immune from foreign competition.
Roberts holds that because of the capital spending boom and the restraint on inflation of imports, economic policymakers can afford to aim for growth rates considerably higher than 3 percent. The advantages of reduced federal deficits, lower unemployment, and increased prosperity more than offset the inflation risk, he maintains.