Are we headed for a capital shortage?;

              ARE WE HEADED FOR A CAPITAL SHORTAGE?
by Dr. WILLIAM C. FREUND, Vice President and Chief Economist, The New York Stock Exchange
Given the gradual pace of recovery, today's economic news
has tended to alleviate our worries about the adequacy of
capital investment. However, unless serious attention is
given to the problems of capital formation in the economy,
today's " g o o d " economic news may be replaced not too far
down the road by news of renewed inflation, reduced rates
of economic growth, and insufficient new jobs for our
growing labor force.
To be sure, the near-term business outlook is encour­aging.
The economic recovery is showing considerable
internal energy. The momentum of expansion is solid, and
well-founded. And few economists doubt the upturn will
last more than a year, despite recent slowdowns.
Is The Present Recovery Sound?
Consumer outlays have spearheaded the economic
recovery. Automobile sales promise to total close to 10
million in 1976, with imports down and domestic output up.
Retail sales are also holding up, and consumer confidence
is likely to receive another shot in the arm with a tax cut
early this year. Moreover, recent moderation in consumer
spending encourages the belief that the expansion will
avoid excesses, thereby prolonging its duration. In the
meantime, retail, wholesale, and manufacturing inven­tories
have had to be replenished in order to keep pace
with sales, while the inventory sales ratio shows a need for
greater production to maintain adequate supplies.
The housing sector has not only turned up, but is begin­ning
to show considerable vigor. It seems reasonable to
expect that total new housing starts in 1976 will reach well
over 1.5 million.
Inflation should hover around 6 percent for the begin­ning
of this calendar year. Although the GNP price deflator
came in just under 4 percent during the first quarter of 1976,
this low rate will probably not be repeated soon. One
reason is that the decline in wholesale food prices of a year
ago is not likely to continue; the consumer price index also
indicates a 6 percent inflation rate.
Interest rates, short-term, may move upward in early
1977, as bank loans rise to finance increased short-term
demands and as the Federal Reserve System tries to main­tain
an even-keel posture. Long-term rates will probably
not show any marked increase. The reason for moderate
long-term credit demands by the corporate sector is that
profits are expected to rise 25 to 30 percent in 1976, and
perhaps another 10 to 15 percent in 1977. Retained earn­ings
will thus provide financial resources which would
otherwise have to be supplied externally. Of course, any
serious heating up of inflation will be reflected in long-term
interest rates, but this development is not anticipated for
the coming year.
New plant and equipment spending is sluggish com­pared
to the relatively optimistic trends in consumer
spending, inventory accumulation, housing, inflation, and
interest rates. While capital investments typically lag
behind business cycle turns, the lag is generally no more
than six months. The economy is now more than a year
beyond the low point of the recession, however, and
capital spending has yet to show a marked improvement.
According to a Commerce Department survey taken in
April and May, business planned to spend $121.03 billion on
plant and equipment in 1976. While this is a 7.3 percent gain
over 1975, it represents only an 0.8 percent rise in "real"
capital spending after stripping away the effects of infla­tion.
This is considerably below the increases in real growth
that hovered around 5 percent following the recession
periods of 1957-58 and 1960-61, and around 2 percent fol­lowing
the recessions of 1953-54 and 1970-71.
This apparent stagnation in real business spending is dis­concerting
to economists, since 1976 was expected to be a
"boom" year for capital goods industries. While a further
rise in capital investment is expected in 1977, a prolonged
sluggishness in investment activity could dampen pros­pects
for a sustained recovery over the next few years.
Indeed, unless capital spending rises more vigorously,
bottlenecks and selected shortages will begin to appear,
thus intensifying inflationary pressures.
What are America's Capital Needs?
While the near-term economic outlook is bullish, there are
growing fears among a number of economists concerning
the long-run growth of the economy. Will there be, for
example, major capital shortages in the decade ahead—
similar to the credit crunches of 1966 and 1969 and the
extreme capital stringency in 1973-74?
To corporate financial officers, those periods of capital
shortage were not an abstract economic projection. Only
the biggest and best-rated firms were able to obtain funds
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