BUSINESS WON'T UNTIE ITS PURSE STRINGS Excess capacity and reform's bigger tax bite will keep a tight lid on corporate investment next year. Equipment purchases will rise a bit, but construction is headed down.
By Sylvia Nasar CHIEF ECONOMIST Todd May Jr. ASSOCIATE ECONOMIST Vivian Brownstein STAFF ECONOMIST Sylvia Nasar RESEARCH ASSOCIATES Catherine Comes Haight, Lenore Schiff

(FORTUNE Magazine) – LATELY business investment has been flatter than Kansas, as they say in Nebraska. But interest rates are down, profits are stronger, and employment -- based on October numbers -- is up. Order books for new equipment are fatter. So an investment revival is at hand? FORTUNE thinks not, alas. For one thing, there was less to the 9% September surge in equipment orders than met the eye. Half of the bulge reflected orders, some foreign, for aircraft parts. And a portion of the increase in domestic orders was probably tax related. For the past couple of years, business has spent furiously in the fourth quarter to boost the year's depreciation. In theory the sharp rebound in profits this summer should loosen purse strings, but in fact it probably won't. Corporate taxes jump next year, so after-tax profits will actually decline a bit in 1987. And depreciation will edge up slightly, so the pool of internally generated funds will barely grow. ''If you believe that cash flow influences investment,'' says Alan J. Auerbach, a University of Pennsylvania economist, ''you have to think that tax reform will have a negative effect on spending in the short run.'' Corporate bond rates of 9%, the lowest since 1979, won't do much to spur spending either. Tax reform will be hardest on construction and utilities, industries that usually get the most mileage out of lower interest rates because they borrow a lot. The highly leveraged corporate sector is cutting back, rather than increasing, the pace of its borrowing. The biggest downer is a surfeit of plants. Factories are operating at a dispiriting 80% of capacity. Worse, the stock of plant and equipment is still growing at a 3% annual rate, somewhat more slowly than a year ago but considerably faster than output. Business is likely to trim capacity growth further in the coming year. One way will be mothballing existing factories; GM, IBM, and GE have all announced plant closings in recent weeks. But new investment will also be held down. That process has already begun: The Conference Board, a business research organization, reported in September that manufacturers cut capital appropriations by 20% in the second quarter. The drive to boost efficiency and cut costs will keep business from reducing spending for new equipment, though. Equipment purchases should rise a percent or so in the year ahead. Aircraft are likely to be the only star performers. With traffic up 8% in each of the past two years, airlines are under pressure to expand capacity; the bulk of the unusually strong orders for new planes in 1984 and 1985 are scheduled for delivery in the next two years. Heavy machinery purchases, which sagged last summer, should pick up with industrial production. Auto fleets should expand modestly. Says Peter D. Packer of Runzheimer International, a management consulting firm: ''Even in the age of telecommunications, there doesn't seem to be a substitute for a personal call.'' But based on the recent weakness in orders, which dropped 17% in September, computer buying is likely to go up just 5% next year, less than the industry hoped. Many types of equipment will not fare even that well. Producers of farm machinery see no end to weak agricultural prices. ''We hope we've hit bottom, but we don't see an upturn even by the end of next year,'' says one gloomy manufacturer. Truckers are not likely to increase their purchases of big rigs. According to William M. Legg, managing director of Alex. Brown & Sons, a Baltimore brokerage house, the fleet is relatively new, and lower fuel prices mean less pressure to upgrade with more efficient vehicles. Construction has already started to sour. By the end of next year, business building will be down almost 20% from its 1985 peak. Oil well drilling has plunged 35% since prices fell last winter and could dip another 10% next year. Electric utilities, which have been paring away excess generating capacity for the past three years, are likely to cut spending another 8% in the year ahead. After slipping for eight of the past nine months, office construction is headed for a sharper contraction. As the preceding Special Report makes clear, stretched-out depreciation schedules, higher capital gains rates, and restrictions on tax shelters will really start to hurt come 1987. Further, vacancy rates are still rising. Hotels and shopping malls are also overbuilt, so commercial construction should fall 8% next year. F.W. Dodge, a construction statistics service, reports that contracts for new factories have been running about 25% below last year's. Industrial construction is likely to limp along at the lowest level in a decade; it has already declined 20% this year. Says William J. Deasy, president of Morrison Knudson, a heavy- construction outfit: ''There are no big drivers out there to foster new expansion.'' All in all, capital spending seems stuck on its plateau for the next year or so at around $460 billion in constant 1982 dollars. That won't push the economy into recession, of course. But investment won't pull the economy out of its slow-growth rut either.