Things will perk up again, perhaps not as soon as hoped

Technology a small part of U.S. output

May 29, 2002|By JAY HANCOCK

FOR economic pessimists, one of the most promising veins of gloom is the capacity utilization report published by the Federal Reserve each month.

Many indicators have turned up smartly this year, but capacity utilization is not one. Even a heroic increase by American workers in the harvest of cars, molybdenum, electricity and so forth for May probably won't be enough to push U.S. capacity utilization much above the near two-decade low to which it sank in January.

Capacity utilization is the output of factories, mines and power plants expressed as a portion of how much stuff the plants could churn out if they were running full-bore.

Usually, industrial facilities are happy to hum along using 82 percent or 83 percent of their potential, on average. In recessions and slowdowns, capacity utilization falls below 80 percent. In severe recessions it plunges below 75 percent, as demand flops and factories lay off workers and shut down machines.

U.S. factories operated at only 74.8 percent of their potential in January, the lowest since 1983. In April, factories ran at 75.5 percent of capacity.

According to some, this under-utilization will hurt economic growth for months or years to come. With only three-fourths of the country's production cylinders operating, the thinking goes, progress can be only so fast.

And when demand does pick up, there will be no need to build factories. With so much idle capacity, managers can substantially boost production with the machines and buildings they already have. Thus, the capital-spending surge that fueled the 1990s boom is unlikely to be repeated soon.

Many analysts portray the current slowdown as fundamentally different from other recessions since World War II. Previous slumps were precipitated by rising inflation, rising interest rates and flagging consumer spending.

The latest recession was caused by over-investment, not frugal shoppers. Consumers kept spending like crazy even after the terrorist attacks, but even that binge wasn't enough to create work for all the production capacity created in the 1990s.

Until the glut of plants and equipment built with Nasdaq mad money can be worked off, many analysts see slow economic sledding, and some even believe that the economy could sink into recession again before long.

The worst business-investment excesses in recent years, of course, came in technology. This shows up glaringly in the Federal Reserve's database.

Last month, factories making communications equipment were working at only 54 percent of capacity, the lowest since the Fed started breaking out separate results for telephones and related hardware in 1967.

Computer plants were running at only 68 percent of potential, up from a 62 percent bottom last November but still near historic lows. Factories making semiconductors and related components were producing at just 59 percent of their maximum rate.

So why am I having such a hard time getting discouraged about the economy?

For one thing, the tech sector is only a small part of U.S. output. Even the entire industrial production segment, from which the capacity utilization figures are derived, accounts for only about 30 percent of the economy.

It's true that technology dreams are what drove the Nasdaq up fivefold and then down 70 percent in six years, but please remember that the stock market is not the economy.

It may be useful to think of the tech-investment overhang as similar to the commercial real estate glut that helped bring on the recession in the early 1990s. Both are minority sectors of the economy whose participants became exuberant and then repentant when their dreams didn't pan out.

Then: see-through office buildings, half-baked golf courses, empty hotel rooms. Now: idle computer plants, too many memory chips, thousands of miles of dark communications fiber.

But there is a whole other economy out there that seems to be doing well. We're mostly a service economy, selling management consulting, dry cleaning, entertainment and financial services. The service economy had a great 2001, despite what you may have heard, increasing output by 2.9 percent.

Just as the economy at large eventually used up all the extra office buildings created in the 1980s, it will also take up most of the present industrial-output slack, perhaps sooner than expected. What isn't taken up will be written off, shut down and redeployed in our useful bankruptcy system.

The recovery of the 1990s took a while to turn into a boom, and it looks like this one will, too.

One side effect of the technology investments of the 1980s and 1990s is that, at the beginning of a recovery, companies can increase output without increasing employment. Another is that businesses can operate more productively and start contributing to economic growth more quickly after setbacks - and that includes tech companies themselves.

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