The Market Surge/Comment Jude Wanniski and Alan Reynolds June 2, 1988

Chances we will dodge the bullet the trade bill has aimed at the world economy have improved markedly in the last few days. The exhuberance on Wall Street reflects this shift in the odds. Over the Memorial Day weekend, the Democrats seemed to come closer to deciding they would rather play out their political strategy on the trade/plant-closing issue in the fall campaign, walking away from the idea of a "compromise.11 Our same sources, who on May 27 reckoned there seemed a 50% chance of an omnibus compromise, on June 1 agreed on 30% as a better number. By at least mentioning protectionism in his veto message, the President caused more small businessmen and entrepreneurs to look at it more closely, we hear, energizing the Chamber of Commerce and putting more heat on members home for the weekend. By the same token, Democrats like Rep. Tony Coelho, who have persuaded themselves they have a winning issue, are pressing for the idea of letting the GOP stew in its own veto juice. This would be marvelous. If George Bush is making his doubts about the bill known to his friend, the Treasury Secretary, that too would be all to the good, cooling JBIII's eagerness to salvage something out of his year of work on the trade bill. At Kennebunkport over the weekend, Bush heard from some of the most avid free traders he knows, including Rep. Bill Frenzel and Dick Rahn of the Chamber. We'll know next week when the Senate returns for its veto vote, certainly sustaining RR. It will then quickly become clear which path will be followed. Could be a big week on Wall Street.

Jude Wanniski 

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COMMENT on Morgan Stanley's Stephen Roach's "Dark Side of a Capital-Spending Boom" that appeared June 2 on The Wall Street Journal's editorial page.

According to this analysis, the wrong businesses are investing in the wrong sorts of plant and equipment: "Almost 60% of the total rise in business spending on capital equipment can be accounted for by...high-technology products." Mr. Roach estimates that 85% of this high-tech equipment has gone into finance, trade and services industries, which allegedly do not have "a meaningful productivity payback." He claims the "factory sector" is still short-changed on "industrial building" and "the heavy machinery that is essential for capacity expansion by Smokestack America." Mr. Roach argues that the U.S. should not invest so much in high-tech equipment because (a) some of it is imported; (b) it supposedly does not make workers more productive; and (c) we are said to be threatened with inflation and a sinking dollar due to inadequate capacity in smokestack industries.

On his own figures, over 40% of the rise in business investment has been of the low-tech sort he prefers, and 15% of the high-tech investment has also gone into manufacturing. This suggests that as much as 49% of the recent business investment may have gone into a sector — manufacturing — that merely accounts for 22% of real GNP. (Commerce Department estimates show manufacturing accounting for 39% of total plant and equipment, but those figures are nominal and do not account properly for the falling costs and improved quality of modern equipment).

The Table below, calculated from Federal Reserve data, shows impressive increases in both manufacturing output and capacity since the first quarter of 1981 (the first quarter of the Reagan era.) With the wisdom of 7 years of hindsight, one might wish that even more capacity had already been added in some industries and less in others, but the increases in capacity have been quite well matched with the increases in output. Unless "smokestack" simply means steel (where shrunken capacity was obviously appropriate), there is no sign that manufacturing has been "capital starved," as Mr. Roach claims, with investment "increasingly misdirected" into "mere…modernization." Indeed, much of the recent increase in U.S. industrial production has been production of business equipment, which can add to capacity, worldwide, not simply use up existing capacity.

Increases in Manufacturing Capacity and Output
1981 I to 1988 I
     Capacity                              Output

                                                                              Nonelectrical Machinery               28.7   32.2%
                                                                              Electrical Machinery                       42.4   34.7
                                                                               Instruments                                      13.7   19.3
                                                                               Paper & Products                           20.7   31.9
                                                                               Chemicals & Products                  18.7   30.0
                                                                               Rubber & Plastics Products        34.9   50.0
                                                                               Autos                                                  41.5   23.1
                                                                               Aerospace & Misc. Transport      18.6   18.7
                                                                               Iron & Steel                                      - 35.0  - 33.5
                                                                               All Manufacturing                             21.2   26.0

The second table, below, deals with Mr. Roach's Claim that high-tech investment has not yielded "productivity gains that would benefit the nation at large."

Annual Increases in Labor Productivity

     Total   Manufacturing

                                                                                                    1974-80   0.3   1.2%
                                                                                                    1981-87   1.3   4.0
 
Since 1980, annual increases in labor productivity have quadrupled for both manufacturing and the economy as a whole! And this neglects increases in the productivity of capital — which has risen by 5.5% a year in manufacturing since 1982. Moreover, the figures for labor productivity in non-manufacturing industries are surely understated, because it is impossible to measure improvements in the quality and speed of, say, financial services (though post-1981 productivity gains were nonetheless 5% a year in banking and 4.8% in federal accounting). Economists and writers should try operating without computers, copiers and FAX machines for a while before deciding that such equipment does not serve any useful purpose, or concluding that industries such as investment banking are inherently less productive than smokestacks.

Alan Reynolds