Businesses Tightening Their Belts

Cost-Cutting Could Slow Economy More

U.S. businesses are holding off on hiring, delaying new investments and trimming expenses, creating a new threat to the nation's economy.

Corporate America is reacting to a pullback by consumers and the crisis in the financial system. Businesses are acting defensively, seeking to avoid the massive layoffs and dramatic falloff in profits like those in 2001, when they were in less sound financial shape.

Innovative Business Interiors, a Silver Spring furniture company, for example, is putting off replacing a nine-year-old sport-utility vehicle. A Floral Affair, a Woodbridge florist and wedding planner, has cut back its inventory of flowers. And SLM Holdings, a Long Island, N.Y., firm that sells software to financial advisers, has turned its salespeople and other staff into independent contractors who work remotely -- and can be easily dismissed if business turns down.

The cutbacks are large and small, but it is the cumulative effect that has economists worried. Business belt-tightening is likely to create an additional drag on the economy, contributing to the period of slow growth that economists almost uniformly expect and to the recession that some fear.

"For the last few years, the emphasis has been on looking for ways to grow," said Mark Toon, chief executive of EquaTerra, a Texas-based consulting firm that advises large companies. "Since August, companies have been looking for ways to reduce costs."

An index of optimism among small business owners fell in January to its lowest point since 1991, according to the National Federation of Independent Businesses. Several surveys of chief executives report confidence in the future at multi-year lows. And purchasing managers at non-manufacturing firms expect a sharp contraction in business activity, according to a January survey by the Institute for Supply Management.

"We're being very conservative in our expenditures," said Diane Sheldon, vice president of ExecuSuites I-270, a Rockville firm that provides conference space and other services to businesses. The firm has postponed replacing older computers and buying new furniture and has instituted a hiring freeze.

So far, this is a more gradual, tentative pullback than the corporate sector experienced in the 2001 recession. Then, businesses had overexpanded -- which was the major cause of the slump -- and consumers and firms in the financial sector were the collateral damage. This time, consumers and the financial sector are cutting back, and businesses are the collateral damage.

Consumers, with their houses less valuable and their ability to borrow money constrained, are spending less, sending ripples through a variety of businesses.

"The corporate sector is not what brought you to the edge, but it could push you over," said Joel Naroff, an economist who has advised businesses for decades.

The crisis in many credit markets has made it more costly -- and sometimes impossible -- for companies to raise money for future investment. At one point last year risky companies could borrow money through the bond market at an interest rate just 2.4 percentage points more than that paid by the U.S. government. Now, the premium is 7.4 percentage points, according to a Lehman Brothers junk bond index.

Businesses entered this period of distress in far better shape than in the last downturn. In the third quarter, just before the economy started its slide, nonfinancial businesses had liabilities that were 3.5 percent higher than their financial assets, according to data from the Federal Reserve. In the comparable period of the last downturn, the fourth quarter of 2000, their liabilities exceeded assets by 24 percent.