Uncertainty is the word of the day for U.S. manufacturers as problems continue to build in key regions of the world while a budget drama with a questionable ending plays out in Washington. The economic impact is most clearly seen in the significant recent weakening of capital spending, a broad and often volatile category of business expenditures. Capital spending is something of a misunderstood variable and in the 1930s, John Maynard Keynes tried to divest economic thinkers of the notion that business fixed investment is entirely a function of calculation. Animal spirits and gut-level entrepreneurial sentiment play a role.
In that sense, business investment has a sporting element to it and it thus makes sense to talk about defense and offense. Even in the most difficult and uncertain of times, businesses have to keep themselves going. Worn-out equipment has to be replaced. Technological advancement creates the need for upgrades. But uncertainty often prevents the jump from this kind of defensive spending to offensive, aggressive investment where businesses are going beyond what is just necessary and thinking about what is possible—in the sense of taking risks, gaining market share, and expanding the frontiers of their enterprises. Recent data suggest that this defensive/offensive theory of capital spending has validity.
In spite of a raft of global economic troubles and the prospect of a fiscal mess in the early part of the new year, this morning's report on durable goods demand for October shows that orders for non-defense capital goods, excluding aircraft, a proxy for business equipment spending, were up by 1.7 percent, although they were flat on a year-over-year (year-to-date) basis, corroborating the flat equipment and software spending growth seen during the third quarter of this year. Clearly, business decision makers are playing defense. In a shaky global economy and a highly uncertain U.S. policy environment, there is not going to be much entrepreneurial business expansion of the type that would result from, and reinforce, a strong economic expansion.
While defensive capital spending is a drag for goods producers, recent data suggest that U.S. factory sector growth, while having slowed significantly, is at least staying above water. In October, demand for the output of industry sectors that are fundamental to manufacturing supply chains such as machinery, primary metals, and fabricated metals were all positive, although machinery demand was down by 3.3 percent on a year-over year basis. While slow but positive growth remains the most likely path for U.S. manufacturing over the short-term, U.S. and world economies that still have the potential to deliver negative surprises suggest that the risks remain on the downside for the manufacturing sector.
But good things will eventually happen. When defensive capital spending gives way to offensive capital spending, U.S. factories will be the first to know.