Thursday, November 29, 2007

What is the Outlook for Business Investment in 2008?

Photo ©Linda & Colin McKie
International Trade

Central bank action to ease interest rates will mitigate the repercussions in the financial markets, but the economy needs to adjust to the new reality that the supply of credit has fallen sharply in real terms. Lenders have fewer reserves with which to cover existing loans. Moreover, their management and investors are less willing to extend what credit they have to finance risky ventures.

Don't expect good news from U.S. retailers in December with regard to holiday sales activity. Cash-strapped consumers are feeling the effects of high energy costs, inflated costs of imports, high credit balances, and reduced borrowing power.

Other sectors are no less troubling. Foreign investors are already showing reluctance to continue funding U.S. trade deficits, reducing the supply of capital available to U.S. business.

State and local governments that had enjoyed expanding tax bases during years of high employment and highly valued housing property are looking for ways to increase taxes, raise user fees and even sell off infrastructure. Aging workforces are a particular problem for state and municipal governments with generous health and pension benefits.

The one bright spot may be business investment. U.S.-based multinationals have earned impressive profits in recent years, helped by the declining dollar and spurred by high demand in developing countries. Suppliers of equipment to build infrastructure and develop raw materials (e.g., Caterpillar, Ingersoll-Rand and Illinois Tool Works) have done especially well, as have branded consumer goods marketers that have developed overseas channels.

It will be interesting to see how big business chooses to invest in 2008. With the continuing drop in the value of the U.S. dollar and rising employment in India, U.S. outsourcing of back office processes to low cost countries has lost some of its appeal. Investment in ERP systems remains steady, but its character is changing. Most major corporations have already installed ERP systems and are now trying to simplify their maintenance of their applications and improve the management of their underlying data. Consulting firms are betting that Service Oriented Architectures (SOA) will begin to supplant development within existing ERP platforms. However, business cases for that kind of development will prove difficult in a business climate focused on maintaining profitability in the face of weak demand.

U.S.-based businesses would do well to continue their investment in capacity to serve foreign markets. Manufacturers benefit both from the low-cost U.S. dollar as well as excess outbound shipping capacity from the U.S. Companies that can open new channels for sales to Canada, Europe, and Asia have the opportunity to add scale to their manufacturing operations.

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