Why an Uptick in Capital Spending Does Not Necessarily Mean an Uptick in Jobs

Brett Buckley submits:Recently, people have been focusing on a particular component of the GDP report released a couple weeks ago. Specifically I refer to gross private domestic non-residential fixed investment in equipment and software (I will hereafter refer to it as "adjusted capital spending" so my fingers don't fall off from typing all that.) Simply put, this adjusted capital spending is investment by businesses in stuff like machinery, tools, computers, etc. It excludes structures and other real property improvements.Positive people note that adjusted capital spending is starting to come back now. Pre-recession, it peaked in March 2008 at $1.128 trillion annualized nominal rate. It bottomed by March 2009 at $0.904 trillion. Through June 2010, it has moved back up to $1.017 trillion, or about halfway back.So, to reiterate, investment by businesses in their infrastructure has come back from the darkest depths of the recession by about half. Who uses all that machinery and tools and computers businesses are buying? People do. And in order to get people to use that stuff for you, you pay them money. We typically refer to that sort of arrangement as a "job."From the December 2007 peak to the December 2009 bottom, we lost 8.467 million private sector jobs (I exclude government jobs because I want to take the temporary census worker noise out, as well as make it comparable to private investment.) Through July 2010, we have made back a whopping 630 thousand private sector jobs (reported August 6th). So private sector jobs have only made back about one-fourteenth what was lost, whereas capital spending has made back half.So does this mean that there is about to be a job hiring explosion because current adjusted capital spending has started to far outpace job creation? I don't think so. Here's why. Businesses need to replace equipment over time because the old stuff they have tends to break down and wear out, irrespective of how many workers they may have. You can only hold off so long before you absolutely must replace stuff or your services will suffer - whether you're in a recession or not. Does a restaurant intend to hire more workers just because they purchased a new refrigerator for the kitchen? Does an office intend to hire more workers just because they bought Windows 7 to replace Windows Vista? Not necessarily at all. They might do that in the middle of a recessive period because they have determined that 1) sales declines have moderated, 2) they have stripped spending down too little for too long and 3) they want to take advantage of some bargains out there in the soft economic times. None of that necessarily means they are hiring another assistant for one of their assistants. In other words, just because capital spending might be finally growing again, that doesn't necessarily translate, dollar for dollar, into jobs.Here's one way I look at that. Over the past two decades, the annual growth rate of nominal GDP before the recession (through March 2008) was 5.3%. Moving forward through June 2010, in other words including the effects of the recession and our subsequent recovery to date, that annual growth rate is now 4.8% for this rough two decade period. So it can be said that the effects of the recession and its recovery to date have impaired long term trend growth by 10%, as the current long term rate is running at 90% of its pre-recession levels (4.8% / 5.3%). Broadly speaking then, any business spending activity that gets us back to 90% of that pre-recessive longer term growth might just be "catching up" to the present conditions, irrespective of where jobs are. Adjusted capital spending getting us beyond 90% might be the sort of legitimate expansion, that would requre robust hiring.Over the same period up to before the recession, adjusted capital spending grew at an annual 5.6%, roughly in line with overall nominal GDP. Updating this number through June 2010 to include the effects of the recession and recovery to date, this growth rate is currently 4.4%, or roughly 80% of the pre-recession growth rates. So it might be that adjusted capital spending growth to date is still just about catching up, and not about looming pent up hiring demand.Take it another (and I think an even more demonstrative) way. By my calculations, in March 2008, in other words pre-recession, the private sector spent $9,776 a year per job on computers, tools, etc. (again, "adjusted capital spending"). Through June 2010's reported numbers (and adjusting for inflation or not doesn't change it much at all), they are presently spending $9,445 per current job. That's only ~3% less per job than pre-recession. In other words, even with this uptick in adjusted capital spending lately, they are pretty much just spending the same amount of money per employee, even though we have 8 million less of them.This does not say to me at all that capital spending suggests businesses are about ready to hire truckloads of people. It says to me more that bosses are getting tired of listening to their employees whine about how they lost an account because the customer relationship management software they bought ten years ago sucks or that the copier is broken; they finally bit the bullet and upgraded so that the few employees they have left can better services the customers.I believe that the effective hold-back on this type of expenditure and other expenses is what has been, in no small part, driving earnings growth and fixing balance sheets over the past couple years now. That they are finally increasing capital spending - and to an amount that appears to me really just in line with the soft economic times - tells me that they have scraped everything they can out of the business plan at this point, and now must rely on actual sales growth.Just something to keep in mind regarding stocks, as earnings season is now subsiding.Disclosure: No positionsComplete Story »