KRUGMAN'S WORLD:

Cautious Capitalists (Robert J. Samuelson, December 22, 2004, Washington Post)

Since their recent low in late 2001, after-tax corporate profits have surged by more than 70 percent; but business investment -- in new computers, software, machinery and buildings -- has revived only modestly, increasing about 18 percent. [...]

The disconnect reflects a sea change in corporate psychology. Call it the return of "risk aversion" -- a fancy phrase for caution. In the late 1990s, the idea of risk virtually vanished. The business cycle was dead; stocks would always rise; globalization was good; the Internet was empowering; CEOs were heroes. Anybody could do anything. Not to worry. Now risk has revived with a vengeance.

Executives often blame their new caution on the Sarbanes-Oxley Act, the federal law requiring companies to maintain stricter financial controls over their operations. Complying with the law is so time-consuming (it's said) that it's hard to concentrate on new business opportunities. At best this is a self-serving half-truth. The larger truth is that America's corporate elite has been scarred by the tech "bubble"; the recession; the Sept. 11, 2001, attacks, and corporate scandals. Everything has changed. The business cycle endures; stocks fall; globalization is hazardous (i.e. terrorism and high oil prices); the Internet is unnerving; CEOs are felons. [...]

There are two ways to look at the new "risk aversion." One is that it's healthy. Everyone realizes that the wild spending of the late 1990s was wasteful. Why invest more when many industries still have surplus capacity? (Note: In November the Federal Reserve's capacity utilization index stood at 77.6, well below the 81.1 average from 1972 to 2003.) Companies also want to make better use of existing computers and software before buying more. This, too, makes sense. The economy may benefit from corporate caution. A slow rise in business investment spending sustains the recovery without promoting inflation or speculation.

The other possibility is that it's a potential calamity. It sacrifices future growth for present profits and leaves the recovery too dependent on strong consumer spending. In the past year average home prices have risen 13 percent. Suppose there's a real estate "bubble" that, once popped, depresses consumer confidence and spending. Indeed, if the recovery stumbles for any reason, corporate caution could quickly make matters worse. Companies might react by cutting new hiring and investments. The slowdown would feed on itself.

Of these possibilities, conventional wisdom favors the first. In 2005 the economy is expected to continue a solid if unspectacular advance. In reality we don't know. Psychology is much underrated as an economic driving force, precisely because it's so hard to measure. In the late 1990s the prevailing euphoria became self-fulfilling -- disastrously so. Now corporate caution could become self-fulfilling in the opposite way. That's not a certainty, but it is a risk.

Hardly surprising that businessmen are a bit skittish when the Democratic Party and the MSM have villified them so fiercely. When the nation's leading newspaper says Enron was worse than 9-11 a rational executive might prefer not to end up like Osama.

Posted by Orrin Judd at December 22, 2004 1:48 PM