Capital Overhangs: Has Equipment Investment Spending Suffered from a Hangover?
McCarthy, Jonathan, Business Economics
This paper examines the role of capital equipemnt overhangs in recent investment fluctuations using a measure based on the Jorgenson neoclassical model of investment. This measure has several advantages over capacity utilization--in particular, wider coverage of the economy and better predictive power for equipment spending. According to our measure, the overhang in aggregate equipment was surprisingly modest in 2000-01, and it has been worked off so that there currently may be an aggregate equipment shortage. Looking at types of equipment, there continue to be notable overhangs in communications and transportation equipment. Estimating the historical relationship between overhangs and investment growth, the effect is generally modest. Consequently, overhangs may have held back aggregate capital spending modestly in 2000-01 but have little effect presently outside of small impacts on communications and transportation equipment.
The behavior of equipment and software expenditures has been attributed a major portion of the "blame" for the last recession and the subsequent tepid recovery. (1) The large role of capital expenditures is illustrated by comparing the contributions of these expenditures to the decline in GDP over the last several recessions (Table 1). Although the decline in GDP in the last recession was small, the contribution of equipment and software expenditures was similar in magnitude to that in the severe recessions of 1973-75 and 1981-82. As such, the equipment and software share of the GDP decline was well beyond that of any other post-war recession.
Even though the correction was severe, the recovery-of equipment and software expenditures has been relatively slow. During this recovery, the path of equipment and software expenditures has been comparable to that following the 1990-91 recession (Figure 1). However, compared to previous recoveries, the recent pace of equipment and software expenditures trails the pace of those recoveries.
[FIGURE 1 OMITTED]
This period of weak investment spending has followed a period of notably strong investment during the 1990s, as shown in Figure 2. For most of the 1990s, equipment spending rose at double-digit rates, a persistent period of robust growth not observed previously in the post-World War II era. Consequently, a number of analysts have expressed concerns that capital overhangs have developed following the "over-investment" of the late 1990s. As a result, according to these analysts, investment will continue to be weak for a considerable period of time to work off these overhangs.
[FIGURE 2 OMITTED]
This paper examines the size of the overhangs resulting from the late 1990s investment boom, the extent of any remaining capital overhangs, and their implications for investment spending prospects. We find that the investment boom of the late 1990s led to aggregate capital overhangs at the end of the decade; however, they had been mostly worked off by the end of 2002. Although overhangs have dissipated for the most part, a disaggregated analysis indicates that overhangs remain in communications and transportation. Consequently, overhangs at this point do not appear to be holding back investment generally. However, other factors such as weak business confidence may be retarding investment at this time (mid-2003).
The rest of the paper is organized as follows. The next section discusses the measurement of capital overhangs. Using our measure, we then present the magnitude of recent overhangs for aggregate capital as well as equipment disaggregated by type and by purchasing industry. We then discuss the effects of overhangs on capital spending, followed by the implications of the analysis for the prospects for capital spending. The last section presents some concluding remarks.
Measuring Capital Overhangs
As stated in the introduction, many commentators have expressed concern that capital spending behavior during this cycle is different from the usual postwar cycle. …