, some of the strains that accompanied the difficult business environment of the past several years apparently still linger. although businesses are replacing obsolescent equipment at an accelerated pace, many managers continue to exhibit an unusual reluctance to anticipate and prepare for future orders by adding to their capital stock. despite a dramatic increase in cash flow, business fixed and inventory investment, taken together, have risen only moderately. indeed, internal corporate funds exceeded investment over the course of last year for the first time since 1975. similar cautious behavior has also been evident in the hiring decisions of u. s. firms, during the past several years. rather than seeking profit opportunities in expanding markets, business managers hunkered down and focused on repairing severely depleted profitability predominately by cutting costs and restricting their hiring. firms succeeded in that endeavor largely by taking advantage of the untapped potential for increased efficiencies that had built up during the rapid capital accumulation of the latter part of the 1990s. that process has not yet played out completely. many firms seem to be continuing to find new ways to exploit the technological opportunities embodied in the substantial investments in high - tech equipment that they had made over the past decade. when aggregate demand accelerated in the second half of 2003, the pace of job cuts slowed. but because of the newfound improvements in the efficiency of their operations, firms were able to meet increasing demand without adding many new workers. as the opportunities to enhance efficiency from the capital investments of the late 1990s inevitably become scarcer, productivity growth will doubtless slow from its recent phenomenal pace. and, if demand continues to firm, companies will ultimately find that they have no choice but to increase their workforces if they are to address growing backlogs of orders. in such an environment, the pace of hiring should pick up on a more sustained basis, bringing with it larger persistent increases in net employment than those prevailing until recently. still, the anxiety that many in our workforce feel will not subside quickly. in march of this year, about 85, 000 jobless individuals per week exhausted their unemployment insurance benefits - more than double the 35, 000 per week in september 2000. moreover, the average duration of unemployment increased from twelve weeks in september 2000 to twenty weeks in march of this year. these developments have led to a notable rise in insecurity among workers. most of the recent increases in productivity have been reflected in a sharp rise in the pretax profits of nonfinancial corporations from a

. of course, the timing and force with which that process of recovery plays out will depend on the behavior of final demand. in that regard, the demand for capital equipment, particularly in the near term, could pose a continuing problem. despite evidence that expected long - term rates of return on the newer technologies remain high, growth of investment in equipment and software has turned decidedly negative. sharp increases in uncertainties about the short - term outlook have significantly foreshortened the time frame over which business are requiring new capital projects to pay off. the consequent heavier discounts applied to those long - term expectations have induced a major scaling back of new capital spending initiatives, though one that presumably is not long - lasting given the continuing inducements to embody improving technologies in new capital equipment. in addition, a deterioration in sales, profitability, and cash flow has exacerbated the weakness in capital spending. pressures on profit margins have been unrelenting. although earnings weakness has been most pronounced for high - tech firms, where the previous extraordinary pace of expansion left oversupply in its wake, weakness is evident virtually across the board, including most recently in earnings of the foreign affiliates of american firms. much of the squeeze on profit margins of domestic operations results from a rise in unit labor costs. gains in compensation per hour picked up over the past year or so, responding to a long period of tight labor markets, the earlier acceleration of productivity, and the effects of an energy - induced run - up in consumer prices. the faster upward movement in hourly compensation, coupled with the cyclical slowdown in the growth of output per hour, has elevated the rate of increase in unit labor costs. in part, fixed costs, nonlabor as well as labor, are being spread over a smaller production base for many industries. the surge in energy costs has also pressed down on profit margins, especially in the fourth and first quarters. in fact, a substantial portion of the rise in total costs of domestic nonfinancial corporations between the second quarter of last year and the first quarter of this year reflected the increase in energy costs. the decline in energy prices since the spring, however, should be contributing positively to margins in the third quarter. moreover, the rate of increase in compensation is likely to moderate, with inflation expectations contained and labor markets becoming less taut in response to the slower pace of growth in economic activity. in addition, continued rapid gains in structural productivity should help to suppress the rise in