Economists still are debating whether the U.S. economy is merely slowing down or heading off a cliff. In fact, the industrial sector--in the throes of its worst downturn in 10 years--may be getting set for a rebound. True, in June, industrial production contracted for the ninth straight month, by 0.7%. Jobs continue to shrink as well. Since last July, some 785,000 workers have been laid off.
Yet a few encouraging indicators have begun to surface. Businesses are finally unloading surplus goods, so inventories have been flat or shrinking for the past four months. New orders are starting to flow. Factory orders, led by surprising demand for durable goods, grew by 2.5% in May.
These telltale signs don't surprise Jerry J. Jasinowski, CEO of the National Association of Manufacturers, the largest U.S. trade group. The crisis isn't over, he says, "but the groundwork for a recovery has been laid." Speaking with Industrial Management Editor Adam Aston, Jasinowski made his case for a rebound in the industrial economy by yearend.
Q: Industrial output has been shrinking since last October. How are we doing today?
A: There are mixed signals in manufacturing right now. Inventories are finally being drawn down, and we're seeing factory orders pick up. More inventory was reduced--through sales and write-offs--through the first half of this year than was built up during all of 2000. These inventory backlogs have to be used up before new orders can trigger new production. So it's no surprise that production numbers were still declining in June. But factory orders blipped up by 2.5% in May; we may see better news in the June numbers.
Q: So you expect industrial production to rebound by the third quarter?
A: You won't see a sharp recovery. It'll take a few months. So we're predicting that industrial production will begin to expand by the fourth quarter.
Q: The story isn't the same across all industries. Internet equipment makers are in dire straits. Which are staying afloat?
A: This recession is the result of four factors: excessively high interest rates in 2000, a spike in energy costs, an overvalued dollar, and an excess buildup of tech equipment. Some industries have just escaped the shock. Those that aren't energy-intensive or that make and sell their goods domestically aren't hurting as much. For instance, consumer nondurables--such as packaged goods from Procter & Gamble (PG), groceries, or apparel--haven't been hit as hard. They haven't had the inventory buildup you've seen in heavy industry or high-tech equipment. Over the past six months, housing has been doing well, too, and even autos, all things considered.
Q: Is this recession purely cyclical, or are we seeing a repeat of the 1970s, when uncompetitive industries were winnowed out?
A: It's predominantly cyclical. The economic shocks in late 2000 caused an unexpectedly sharp drop in demand, and inventory began to build up. The converse is that the recovery will be cyclical, too, so there's reason to be cautiously optimistic. The inventory problems will work themselves out. The Fed has lowered interest rates by three percentage points since early January. And, with help from the tax cuts, consumer confidence remains strong. Plus, energy prices have fallen sharply in just the past month. There are really only two lingering negatives in the picture. One is the strong dollar and the related issue of overall slowdown in global growth. The other is that capital spending is dead in the water, and that won't turn around this year.
There is one important structural shift going on in the midst of all this. Over the past decade, production has been globalized. This has greatly increased worldwide capacity and intensified competition across the board. This makes it almost impossible to raise prices for manufactured goods.
Q: Why is the dollar's strength so stubborn?
A: Falling interest rates should already have brought the dollar down. Instead, it continues to appreciate. This is partly because U.S. economic fundamentals are still good compared with Europe and Japan. The euro is also weak because Europe's leaders have been inept at the political task of pulling together and talking up the currency. Plus, the euro is still a virtual currency--it doesn't physically exist yet, so it remains an abstract financial matter. The other thing driving demand for dollars: the enormous dollar-based black market economies in Eastern Europe, Africa, and elsewhere.
Q: What can the Fed do, beyond lowering interest rates further?
A: The dollar was last stubbornly overvalued in the 1980s. It didn't fall until the Plaza Accords led to coordinated international intervention to bring it down. It's not a perfect answer, but it worked in 1985. The strong dollar is hurting not just the U.S.; it forces the European Central Bank to raise interest rates, which in turn slows European growth.
The Fed has to recognize that it should do more than reduce interest rates. There's a growing consensus that the Fed should behave as a world central banker. Greenspan should be looking at very large increases in the money supply in order to improve worldwide liquidity. Right now, deflation is a bigger threat to the world's economy than is inflation.
Q: What about inventories? It seemed ironic that Old Economy manufacturers cut back production at the first signs of a slowdown. But many presumably more nimble high-tech outfits didn't turn off the lines so soon.
A: Heavy manufacturers, like the car companies, started cutting production by the fourth quarter, as soon as they saw the pipeline beginning to clog up. The high-tech players are more wired up in terms of software-based control of their sales, supplies, and manufacturing. But they believed their own press releases--that the New Economy had eliminated inventory cycles. This was an enormous miscalculation. Another factor is that many of the newcomers had never been through a downturn before, so they had no idea how costly this sort of inventory glut can be.
Q: Capital investment generally falls in a recession. Is this the case now?
A: Yes, but the slowdown in capital spending comes after a decade of record levels of investment. The slowdown now is partly cyclical: You won't see increases in capital spending through the rest of this year. But there's also a hangover from the binge of investment, especially in tech gear and services, that took place in the 1990s. My guess is that the sector will cut long-term capital spending by about 25%, because many managers feel they've wasted some recent investment.
Another factor is that more companies are using EVA [economic-value-added] analysis instead of traditional, return-on-investment measures to assess the value of a project. Methodologically, EVA inclines you to invest less, because you look more critically at the payoff from capital spending.
Q: Some spending will continue, though. What sort of technologies are at the top of the shopping list?
A: The knife will be out for big new capital-spending projects for physical goods. There will be a bias toward software and services. Software and technology prices have been falling steadily--the recession is accelerating that process--and companies are looking for software that can boost productivity. This means more investment in enterprise resource planning systems.
Q: Industrial productivity increased dramatically in the 1990s [chart]. Where will the next wave of productivity gains come from?
A: During the 1990s, manufacturing productivity grew by an average of almost 5% per year, up from about 3.5% in the 1980s. In that same period, the yearly growth of nonfarm business productivity picked up between 1.5% and 3%. So overall productivity growth in the 1990s was really driven by improvements in the manufacturing sector.
The impetus for this came from a decade-long boom in capital investment, technological progress, and spillovers from improved business processes. By this, I mean the growing focus on quality improvement through methods like Six Sigma. These tools help a company enhance everything from capital spending to customer service. This will continue.
Q: So in the wake of the New Economy crash, what's to become of the Old Economy?
A: The dot-com hype is a bust, but the full application of computers and software to productivity improvements is in its early stages. The networking of the modern corporation will continue with a vengeance for the next decade. I predict productivity growth will stay in the 3% to 4% range for as far as the eye can see.