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Beware Of Bottlenecks

Economic Trends


Factory operating rates are surging

While manufacturing activity is accelerating in most industrial nations, it is the U.S. that is leading the way. According to the Federal Reserve, factory output in the six months through March rose at a hefty 6.9% annual rate, more than double the 2.8% pace of the prior year.

Ordinarily, such a sharp acceleration in manufacturing activity at a late stage in an economic expansion would be setting off inflation alarms. But many observers point to strong capacity expansion as an offsetting factor. With plant capacity growing at a 4.1% annual rate--more than double the pace of a few years ago and the highest in more than 25 years--they see little danger of production bottlenecks ahead.

Economist John Youngdahl of Goldman, Sachs & Co. disagrees. He points out that rapid capacity growth in recent years has been concentrated in a narrow group of industries that account for only one-fifth of industrial output: electrical machinery, including semiconductors, which is posting 15.5% capacity growth this year, and industrial machinery, including computers and office equipment, which is clocking expansion at a 12.7% annual rate.

Meanwhile, notes Youngdahl, capacity in all other manufacturing industries, which account for four-fifths of output, is growing at a mere 1.5% to 1.7% annual pace. Yet it is precisely these industries where operating rates have been surging higher--enough to raise overall factory utilization by a full percentage point in the past nine months, to 83.3% in March. (Meanwhile, operating rates in industrial and electrical machinery have leveled off and even declined).

What has been occurring, says Youngdahl, is "the diffusion of rapid demand-led production gains from a narrow band of high-tech sectors to almost all manufacturing groups." If recent rates of output growth continue, he figures that overall manufacturing capacity use will hit 85% by yearend--an inflationary danger zone breached in only 37 months of the past quarter century.

The implications of this picture are double-edged. On the positive side, it suggests that capital spending will stay strong, as higher operating rates inspire more industries to invest in expanded capacity. Such spending promises to shore up growth if consumption slows, Youngdahl says, and will help keep inflation at bay over the long run.

In the short term, however, he worries that buoyant consumption--along with firm capital spending--may push up operating rates even more. And the resulting bottlenecks could finally give producers both the incentive and the leverage they need to raise prices.

Youngdahl believes that the Fed is well aware of such risks. "With unemployment low and with the likelihood of rising physical capacity constraints ahead," he says, "we're looking for further monetary tightening both in the short term and over the next year."BY GENE KORETZReturn to top

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How the invisible hand curbs hikes

A widely held view of the medical marketplace is that health-care providers engage in cost-shifting--charging some patients high fees to offset losses on others. If a government insurance scheme or a large insurance company cuts its payments for the group it covers, so the story goes, providers will recoup their lost income by simply raising fees for other groups.

As far as doctors are concerned, however, cost-shifting may be more of a myth than a reality, according to a new study by Mark H. Showalter of Brigham Young University. Using survey data from all 50 states in the mid-1980s, Showalter found that doctors in states with higher Medicaid reimbursement rates tended to charge privately insured patients higher fees than docs in states with lower Medicaid rates. At the same time, docs in states with low Medicaid fees not only charged private patients less but saw fewer Medicaid patients.

Since his analysis indicated that Medicaid reimbursement rates affected private fees rather than vice versa, Showalter concludes that the doctors were prevented from cost-shifting by market pressures. With private fee levels set by supply and demand, their best strategy in the face of lower Medicaid rates was to reduce their private fees--and thus attract more private patients--while cutting Medicaid caseloads.

Showalter's study has intriguing implications for the health-care revolution. It suggests that fears of government fee controls' resulting in cost-shifting are exaggerated (although it raises the problem of lower Medicaid or Medicare caseloads). And it indicates that doctors are highly sensitive to competitive pressures--just like ordinary businessmen.BY GENE KORETZReturn to top

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