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THE HUM OF FACTORIES GROWS FAINTER ALL THE TIME
Manufacturing is flat on its back--again. For the third time in three years, factory output is falling. In 1990, the reason was the recession. In 1991, it was the aborted recovery. In 1992, relentless stagnation here at home has crippled production, and weakness abroad has kicked away the crutch: exports.
The factory sector has grown increasingly dependent on export growth to carry it through tough times. Without strong foreign demand, the U.S. economy's drop in 1990-91 would have been much steeper. Now, however, exports have slowed sharply--especially shipments to Europe (chart). So, as factories lose that cushion, the entire economy is feeling the difference.
Because of export declines in July and August, a big widening of the trade deficit subtracted a bundle from third-quarter growth in real gross domestic product. A worsening trade gap helps to explain why the economy felt so lousy last quarter, despite a decent gain in consumer spending. It appears that growth in real gdp last quarter was hard-pressed to match even the second quarter's feeble gain of 1.5%.
Trouble is, the problems in manufacturing suggest that fourth-quarter growth could be just as frail. Weak demand caused inventories to pile up last quarter, especially at factories. Excessive stock levels, a trickle of new orders, and a shrinking order backlog imply further cutbacks in manufacturing output and employment.
And no one seems able to help. Detroit has slashed its plans for fourth-quarter output amid slumping car sales. The recovery in homebuilding is pale by past standards. Consumers, who let their spending run ahead of their income last quarter, may be tapped out as they head into the holiday buying season. And defense cutbacks continue to exert a powerful downdraft. Add in the bad news on exports, and factories are clearly in trouble.
Manufacturing's woes are evident in the latest data. Industrial production at the nation's factories, utilities, and mines slipped 0.2% in September, but the weakness was worse than that. A weather-related surge in utility output propped up the numbers. Manufacturing output alone fell 0.4%, the third drop in the past four months. Factory production now is no higher than it was in April. In fact, output remains 1.6% below where it was when the recession began in 1990.
As a result of production cuts, utilization rates are also slipping. Operating rates for all industry dropped to 78.4%, from 78.7% in August, and capacity use among manufacturers fell to 77.7% in September, from 78%. Factories will have to cut back their operations even more until customers emerge to buy their products. For now, however, there is no flicker of light at the end of their recession tunnel.
Take domestic demand. Consumer spending increased handily in the third quarter, but the advance was not matched by a pickup in jobs or income. Real outlays appear to have risen more than 3%, but real aftertax income did not grow at all. As a result, the buying pace in the fourth quarter may well be much lower. That was the pattern consumers followed in 1992's first half, when they couldn't shop fast enough in the first quarter and then stayed at home in the second.
Housing, at least, was looking somewhat better at the end of the third quarter than it did at the beginning. Housing starts edged up 1.2% in September, to an annual rate of 1.26 million (chart). And the Commerce Dept. revised the August gain to 12.6%, better than the already strong 10.4% increase previously reported.
Starts grew at a 20.8% annual rate in the third quarter, partially reversing their stumble in the second. That bounce--helped by the lowest mortgage rates in 20 years, plus rebuilding after Hurricane Andrew--should help demand for home-related products and construction supplies this quarter.
That's good news for the producers of those goods, because they muddled through a dismal third quarter. Output of consumer durables, including appliances, carpeting, and furniture, was basically unchanged last quarter. And the production of construction supplies rose at an annual rate of only 1.7% in the third period.
But other signs aren't nearly as bright. Fading domestic demand was evident in lagging auto and truck production, which was expected to give the third-quarter economy a healthy boost. Instead, output for the quarter fell at a 17.5% clip. And fourth-quarter car demand got off to a shaky start. Sales of new U.S.-made cars slipped to a dismal 5.8 million annual rate in early October, down from a 6.3 million pace for all of September.
In addition, the defense industry continues to gasp for air. No single factory sector has taken as big a hit as suppliers to the military. Defense output has been unraveling for two years. As total factory production has flattened out, the defense industry has lost 16.5% of its output since 1990 (chart).
Defense contractors have accounted for some two-thirds of the factory jobs lost in the last two years, and they have seen their backlog of unfilled orders shrink by 12.4% over the past year. With each Presidential candidate vowing to cut the Pentagon's budget further, the outlook is for even more declines and the continued dismantling of the defense industry in coming years.
At least, one source of demand--exports--is likely to be in a better position to help the factory sector next year. The recent problem with exports is caused by the global slowdown rather than uncompetitive pricing. That's why the trade outlook depends less on recent swings in the dollar and more on economic recoveries around the globe, probably later on next year.
In August, the merchandise trade deficit widened to a surprising $9 billion--the biggest gap in nearly two years. Exports dropped by 6.1%, to $35.5 billion. That was the second consecutive loss in foreign shipments.
Imports fell by a smaller 1.3% in August, as declines in foodstuffs, petroleum, and consumer goods offset gains of capital goods and cars. In particular, capital goods have increased for three consecutive months, accounting for 39% of the increase in imports since May (page 26). Imports are likely to grow even more when the U.S. recovery takes a firmer hold.
American exporters, meanwhile, are hoping for signs of recovery in major U.S. trading partners, especially Europe. That remains the prime export market, but shipments across the Atlantic have been declining in 1992.
Growth abroad should strengthen next year. Japan's recent package of fiscal stimulus will lift that economy. In Europe, some countries have already cut interest rates in response to their floundering economies, and rate cuts elsewhere--even in Germany--seem inevitable.
A rebound in exports in 1993, though, will not come soon enough to reverse the recent backup of inventories. Manufacturers who boosted output in the second quarter in anticipation of a consumer-led rebound are now caught with too many goods in their warehouses.
Total business inventories rose for the third straight month in August, up 0.3%. Factory stock levels were up by a larger 0.5%, even though shipments fell 2.4%. As a result, the ratio of factory inventories to sales jumped to almost 1.6 in August, from a record low of less than 1.55 in June (chart). The increasingly rapid response of factories to inventory changes suggests further output cuts this quarter.
Stronger consumer spending--which might get some help from recent gains in homebuilding--could short-circuit this latest manufacturing recession before it has a chance to drag down the entire economy. But if shoppers are to stay in the stores in the fourth quarter, they will have to see faster job and income growth. Only then will manufacturers be able to pick themselves up, dust themselves off, and start moving forward again.JAMES C. COOPER AND KATHLEEN MADIGAN