October 13, 2004
Normally, a survey of top executives about the economy
should receive little attention from economists. After all, forecasters spend their lives analyzing conditions
while CEOs are, or ought to be, focused on their company’s strategies and
However, some of the expectations by people in the
trenches should be heeded by the big picture forecasters.
One of the most difficult components to forecast is
capital spending. Listening to
the CEOs and their desires to increase such spending provides some guidance.
(However, shifting cash flow, changing interest rates, and
achievement of sales projections could alter that guidance as the year
expectations about the latter variables are what a good economist may bring
to the table.
Anyway, CEOs are not happy about the economy they see
on the horizon. According to
the Business Council survey, they see less than 2 percent growth for the
U.S. economy. Only a fifth see
sales growth slowing for their own companies, however.
(We will ignore the inconsistency for now.)
Surprisingly, half the executives believe profit growth
will accelerate despite the lapse of the accelerated depreciation provision
at the end of this year and the less than trend growth rate projected for
the economy. If their economy outlook is on target, there will be a lot of
disappointed CEOs when they tout up their profits.
Of course, I could go on and on in explaining the
economic inconsistencies of such a survey and why most CEOs really need
advice from economists.
Instead, I should like to drill down to two issues
uncovered by the survey.
The survey suggests that capital spending will rise
only slightly next year. Only
42 percent expect to increase capital spending modestly in 2005. As spending adjusted for price declines actually rose at
double digits this year, that expectation does not bode well for
continuation of strong capital spending.
As the year progresses, sales may surprise, capital
costs may change, and cash flow could be significantly different than
projected. If so, capital
spending could be different from these expectations.
However, profit growth probably is too optimistic
(certainly that is true for the anticipated economy).
Most CEOs with whom I talk are surprised at how high I expect short
term interest rates to go and are not aware of the changing tax consequences
of their investment decisions. In
both cases, these changes would work against capital spending.
U.S. sales may be higher than they expect (my forecast
is being market down because of high energy prices but still exceeds 3
percent growth for the year). Nevertheless,
that favorable sales outcome will merely offset the unfavorable profit,
capital cost, and cash flow prospects.
Therefore, a continuation of double digit growth in deflation
adjusted capital spending is unlikely.
I now am using something closer to 6 to 7 percent gains.
The other issue is their reason for economic concern.
They worry about high medical costs for their benefits programs.
Indeed, stemming the medical cost growth may do more to preserve U.S.
jobs than any tax or subsidy scheme that economists may be drafting to stem
the outsourcing tide.
But their major worry is about terrorism.
I have tried to explain to my business audiences that terrorism is an exogenous variable. By that I mean that it is important and will alter the economic landscape. However, it is not a variable that can be used to make good economic decisions about hiring, capital spending, the abandonment or pursuit of markets, etc. It impacts the system but is not part of the system.
Now I do not wish to belittle terrorism.
A dirty nuclear bomb might do immense damage.
Certainly, we should invest in protection from such outcomes and make
clear that if such activity occurs the response will be swift and
But you do not alter the investment and hiring decision
because of exogenous variables. You
do not let such possibilities freeze decision making. (Consumers show no evidence that terrorism fears are
impacting their spending.)
One would think that CEOs would understand that they
cannot change their investment plans because terrorism may strike.
Indeed, if they continue to do so, they are allowing terrorism to win
through threats alone.
Let us be vigilant and do what needs to be done to
avoid and, if necessary, repel and defeat terrorism.
However, let that be outside the boardroom decision making process.